Too Much in Retirement Plans??

[The White Coat Investor]

Kon Litovsky wrote:

The White Coat Investor wrote:

Yes, the RMD at age 70 on a $10M tax-deferred account is about $360K. Not enough to get a married couple into the highest bracket by itself. But my point is a $2M or $3M or $5M tax-deferred account is hardly an RMD problem.

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The point I was making is that you can potentially save significant amount in taxes by doing the Roth conversion vs. not doing it, but many factors will affect whether this is a strategy worth taking, and that it does not take $10M for the Roth conversion to make sense (at that point, the savings would be substantial), and someone with as little as $2M can benefit.  I prefer to trust my own calculations (I actually assumed that in retirement the tax rate would not be very high), so unless someone can produce a comprehensive model that shows that Roth conversions are not recommended for the same set of assumptions, I believe that my answer is correct given the conservative assumptions I’m making.  One factor that significantly affects the outcome is longevity, so the longer one is around, the more sense this strategy makes.  I’ll definitely try to publish an article on this topic with the assumptions and calculations one of these days.

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Oh, I agree you don't need an IRA anywhere near $2M to have a Roth conversion make sense. I was reading the OP's question as if it was possible to have a "too big" IRA, and I think probably not within the range that docs can realistically get to.

[litovskyassetmanagement]

PhysicianOnFIRE wrote:

TheGipper wrote:

Thanks Kon, perhaps I’ll pay you a visit when I’m ready to call it quits. Your advice is always spot on and you are local for me!

Potential road block (even if I successfully build up my taxable account and delay SS to age 70) are other things I also would love to accomplish in these low income early retirement years in addition to Roth conversions.

1) Tax gain harvesting
2) Sale of rental property to minimize capital gains (and retirement hastle)
3) 457b distributions

The bucket only holds so much up to 15-25% effective tax. Seems the earlier people can retire the larger the benefit of Roth ladder and tax minimization strategies. That proposed $80,000 Trump standard deduction would sure help me along.

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I’m with you TheGipper. Roth conversions can wait until retirement. It’s rather obvious, but also true that the earlier one retires, the easier it will be to make those conversions in the 15% and 25% tax brackets.

#1: You’ll have smaller tax-deferred balances to convert. #2: You’ll have more years to make the conversions prior to age 70.5.

I think it’s a great idea to max out all tax-deferred space when you’re working and in a high tax bracket. I’m a fan of doing so for 15 to 20 years while also building up a sizable tax account. Hit FI, then do what you want — retire, go part-time or change career paths, or keep on doing what you love and create multigenerational wealth.

Best,

PoF

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Dental (or medical) practice owners might have an opportunity to make a massive Roth conversion when they are just starting up their practices and have some previous tax-deferred assets.  There is a brief window of opportunity to do this, especially if the first and/or second year's income is not going to be very large.

[PhysicianOnFIRE]

TheGipper wrote:

Thanks Kon, perhaps I’ll pay you a visit when I’m ready to call it quits. Your advice is always spot on and you are local for me!

Potential road block (even if I successfully build up my taxable account and delay SS to age 70) are other things I also would love to accomplish in these low income early retirement years in addition to Roth conversions.

1) Tax gain harvesting
2) Sale of rental property to minimize capital gains (and retirement hastle)
3) 457b distributions

The bucket only holds so much up to 15-25% effective tax. Seems the earlier people can retire the larger the benefit of Roth ladder and tax minimization strategies. That proposed $80,000 Trump standard deduction would sure help me along.

Click to expand...

I'm with you TheGipper. Roth conversions can wait until retirement. It's rather obvious, but also true that the earlier one retires, the easier it will be to make those conversions in the 15% and 25% tax brackets.

#1: You'll have smaller tax-deferred balances to convert. #2: You'll have more years to make the conversions prior to age 70.5.

I think it's a great idea to max out all tax-deferred space when you're working and in a high tax bracket. I'm a fan of doing so for 15 to 20 years while also building up a sizable tax account. Hit FI, then do what you want -- retire, go part-time or change career paths, or keep on doing what you love and create multigenerational wealth.

Best,

PoF

[litovskyassetmanagement]

TheGipper wrote:

In an ideal world, you’d eventually find me in Sanibel Island for at least 7 months per year, but something tells me life and my four kids will not allow me to escape the clutches of MA that easily.

Perhaps you might leave us with a recommendation for someone local who is excellent at Roth conversion and other estate planning before we lose you to Sarasota.

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I know a good estate planning attorney here in MA, but attorneys are not known for their modeling and math abilities. Everything is virtual nowadays, and honestly, I don't have a single doc I work with from MA - everyone is all across the country, so 'in person' is not necessary (in fact, it is an obstacle, esp. in MA given the traffic and distances).  I was looking for a 'local' CPA (just because some CPAs want to work locally for whatever reason), and by the time I got in touch with him, he ended up in Naples.  There was a recent story about a NH lady who just packed her suitcase and left for Sarasota without telling her relatives. Boy were they upset, in fact so upset that they declared her a missing person and called the police ;-)  Nothing is impossible - with the tax savings from moving to FL you can probably buy each of your kids a nice little house ;-)

[TheGipper]

In an ideal world, you'd eventually find me in Sanibel Island for at least 7 months per year, but something tells me life and my four kids will not allow me to escape the clutches of MA that easily?.

Perhaps you might leave us with a recommendation for someone local who is excellent at Roth conversion and other estate planning before we lose you to Sarasota.

[litovskyassetmanagement]

TheGipper wrote:

Thanks Kon, perhaps I’ll pay you a visit when I’m ready to call it quits. Your advice is always spot on and you are local for me!

Potential road block (even if I successfully build up my taxable account and delay SS to age 70) are other things I also would love to accomplish in these low income early retirement years in addition to Roth conversions.

1) Tax gain harvesting
2) Sale of rental property to minimize capital gains (and retirement hastle)
3) 457b distributions

The bucket only holds so much up to 15-25% effective tax. Seems the earlier people can retire the larger the benefit of Roth ladder and tax minimization strategies. That proposed $80,000 Trump standard deduction would sure help me along.

Click to expand...

You got a lot of fun ahead!  In about 1 year you'll be able to find me on the beaches of Sarasota ;-)  (lots of sunshine and no state tax).

By the way, you might also benefit from establishing a residence in a place other than MA, as in MA they are going to get very greedy for your money, and sooner than you think.  It helps not having to pay a state tax (because you might also be paying 3.8% net investment income tax on top of that).

[TheGipper]

Thanks Kon, perhaps I'll pay you a visit when I'm ready to call it quits. Your advice is always spot on and you are local for me!

Potential road block (even if I successfully build up my taxable account and delay SS to age 70) are other things I also would love to accomplish in these low income early retirement years in addition to Roth conversions.

1) Tax gain harvesting
2) Sale of rental property to minimize capital gains (and retirement hastle)
3) 457b distributions

The bucket only holds so much up to 15-25% effective tax. Seems the earlier people can retire the larger the benefit of Roth ladder and tax minimization strategies. That proposed $80,000 Trump standard deduction would sure help me along.

[litovskyassetmanagement]

TheGipper wrote:

Thank you gentleman, great advice as always.

I’ve read most of what James Lange has written and much of his radio podcasts and while I’m a huge fan of his estate and trust planning advice, I think he may sometimes err in recommending Roth conversions too early for high earners by overestimating the inflation adjusted compounding of tax free growth. I tend to agree with others such as Harry Sit, who advocate high earners holding off from Roth conversions during working years.

I think the Roth ladder conversion strategy from retirement until age 70, while deferring RMDs and SS until age 70 is usually the winning strategy.

Depending on the size of ones IRA, how early a retirement is feasible, and ability to otherwise minimize taxable income, one could convert millions to Roth staying under a 25% effective tax rate. With a smaller IRA, one could convert the bulk at less then 15% effective tax.

Gamble is future tax law changes, but while the top rate may go up in the future, I think we are safe in that the effective rate we will pay in retirement for Roth conversions should be less than the 45% marginal high earners would pay now.

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Bingo.  My calculation show that the average tax rate while making conversions is relatively low when averaged out over the lifetime (though for a large account, you might have several years of extremely high tax rates, the end result is more than satisfactory, in my opinion). In fact, the $10M account is problematic because that would require a lot of after-tax cash and more years in the highest tax brackets, but again, the tax savings will more than offset that expense.

[TheGipper]

And Jim to answer your question my goal is to both maximize net worth and to pass on sizable estates to my kids. Roth IRAs seems the ideal vehicle for for the latter as of now, while stretch IRA remains, though I realize that my kids incomes, tax brackets, and future estate tax laws could make other vehicles more attractive in the future.

[TheGipper]

Thank you gentleman, great advice as always.

I've read most of what James Lange has written and much of his radio podcasts and while I'm a huge fan of his estate and trust planning advice, I think he may sometimes err in recommending Roth conversions too early for high earners by overestimating the inflation adjusted compounding of tax free growth. I tend to agree with others such as Harry Sit, who advocate high earners holding off from Roth conversions during working years.

I think the Roth ladder conversion strategy from retirement until age 70, while deferring RMDs and SS until age 70 is usually the winning strategy.

Depending on the size of ones IRA, how early a retirement is feasible, and ability to otherwise minimize taxable income, one could convert millions to Roth staying under a 25% effective tax rate. With a smaller IRA, one could convert the bulk at less then 15% effective tax.

Gamble is future tax law changes, but while the top rate may go up in the future, I think we are safe in that the effective rate we will pay in retirement for Roth conversions should be less than the 45% marginal high earners would pay now.

[litovskyassetmanagement]

The White Coat Investor wrote:

Yes, the RMD at age 70 on a $10M tax-deferred account is about $360K. Not enough to get a married couple into the highest bracket by itself. But my point is a $2M or $3M or $5M tax-deferred account is hardly an RMD problem.

Click to expand...

The point I was making is that you can potentially save significant amount in taxes by doing the Roth conversion vs. not doing it, but many factors will affect whether this is a strategy worth taking, and that it does not take $10M for the Roth conversion to make sense (at that point, the savings would be substantial), and someone with as little as $2M can benefit.  I prefer to trust my own calculations (I actually assumed that in retirement the tax rate would not be very high), so unless someone can produce a comprehensive model that shows that Roth conversions are not recommended for the same set of assumptions, I believe that my answer is correct given the conservative assumptions I'm making.  One factor that significantly affects the outcome is longevity, so the longer one is around, the more sense this strategy makes.  I'll definitely try to publish an article on this topic with the assumptions and calculations one of these days.

[litovskyassetmanagement]

TheGipper wrote:

Thanks Kon. For me, I’m resolved not to do any Roth conversions prior to retirement, and plan large annual Roth conversions between retirement and age 70. I’ll surely enlist the help of software and professionals to get the optimal annual amount to convert when the time nears.

For now the question is how much into cash balance plan vs taxable. My CBP allows as little as 5k or as much as $150k per year. I’ve gone back and forth about the merits and risks of overfunding a DCBP with Rex, but for now I still favor this approach for a cash balance plan that allows IRA rollovers and keeps a fairly aggressive 5% target benefit and 60/40 AA. Just can’t pass up the 45% upfront tax-deferral. If it looks as if my taxable account may lag what is needed to cover Roth conversions or other expenses, I’ll ramp it up and cut back on the DCBP plan on next election cycle.

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If you are in the highest tax bracket, by all means max out all of your tax-deferred accounts. I would prefer to keep a decent size portfolio after tax as well to generate tax-free income so that you don't have to withdraw from retirement plans, at least initially.

[The White Coat Investor]

TheGipper wrote:

Kon or WCI, without asking for any heavy calculations and assuming the following assumptions, how much do you think is too much in tax deferred account to be able to pull off significant Roth conversion of a bulk of IRA until larger RMDs in 70s/80s start to dominate and push back into an effective tax rate equaling their current top marginal tax rate.

1) Two physician couple will retire at age 60.

2) Lets assume essentially no taxable income from retirement at age 60 until age 70 when plan to take delayed SS and forced RMDs begin.

3) Taxable account, tax free proceeds from primary home downgrade, and liquid savings will be enough to cover any Roth conversions and live off during age 60-70.

4) 95% of retirement funds in traditional IRAs, much smaller amount in Roth (only from annual backdoor Roth conversions).

?3 million, ?5 million, ?10 million ?20 million

Even if eventually RMDs pushed the couple in this example back into an effective tax rate of 35%+ in their mid 70s or early 80s, would not they still be better off NOT doing Roth conversions will they are still working and are guaranteed to pay 45% on the conversion?

 

 

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Interesting financial situation. Not clear what your goal is. Is it to leave as large of a Roth IRA as possible to your heirs?

Remember the concept of a "too large" tax-deferred account can only be considered in comparison to something else. So what if I have an $80M IRA, right? So I've got to take some out every year, spend as much of it as I can, and then reinvest the rest in taxable? No big deal. First world problem for sure.

So the real questions are:

1) Should you invest in taxable instead of a tax-deferred account because you project having a big IRA later? The answer is no. You should max out retirement accounts for tax and asset protection purposes.

2) Should you do Roth or tax-deferred 401(k) contributions? Complex issue, discussed here:https://www.whitecoatinvestor.com/should-you-make-roth-or-traditional-401k-contributions/

3) Should you do Roth conversions? If so, when and how much? Mike Piper had a nice article about it this month. http://www.obliviousinvestor.com/when-does-it-make-sense-to-do-a-roth-conversion/

[The White Coat Investor]

TheGipper wrote:

Kon or WCI, without asking for any heavy calculations and assuming the following assumptions, how much do you think is too much in tax deferred account to be able to pull off significant Roth conversion of a bulk of IRA until larger RMDs in 70s/80s start to dominate and push back into an effective tax rate equaling their current top marginal tax rate.

1) Two physician couple will retire at age 60.

2) Lets assume essentially no taxable income from retirement at age 60 until age 70 when plan to take delayed SS and forced RMDs begin.

3) Taxable account, tax free proceeds from primary home downgrade, and liquid savings will be enough to cover any Roth conversions and live off during age 60-70.

4) 95% of retirement funds in traditional IRAs, much smaller amount in Roth (only from annual backdoor Roth conversions).

?3 million, ?5 million, ?10 million ?20 million

Even if eventually RMDs pushed the couple in this example back into an effective tax rate of 35%+ in their mid 70s or early 80s, would not they still be better off NOT doing Roth conversions will they are still working and are guaranteed to pay 45% on the conversion?

 

 

As a general rule, don't pre-pay your taxes.

As a general rule, if you can pre-pay your taxes at a rate dramatically lower than you would eventually pay them, then prepay them.

Too many people are afraid of taxes in retirement. It leads them to make dumb investing decisions, like buying cash value life insurance, investing in taxable before maxing out retirement plans, doing Roth contributions during peak earnings years when tax-deferred options are available, doing Roth conversions in high tax brackets etc. There's even a book I reviewed that talks about how awesome it must be to not pay any taxes in retirement. Except the entire premise of the book is wrong. https://www.whitecoatinvestor.com/is-a-zero-percent-tax-bracket-in-retirement-a-good-idea/

James Lange gets this one right in his book Retire Secure. The general rule is to leave your taxes in the tax-protected account as long as possible.

https://www.whitecoatinvestor.com/which-assets-to-spend-first/

Pre-SS Roth conversions make sense when you can do them at some low bracket like 15% or 25% or something. They also make sense for people who will always be in the highest bracket. For the rest of us, leaving that money in tax-deferred accounts as long as possible is often the right answer.

[The White Coat Investor]

Yes, the RMD at age 70 on a $10M tax-deferred account is about $360K. Not enough to get a married couple into the highest bracket by itself. But my point is a $2M or $3M or $5M tax-deferred account is hardly an RMD problem.