L1: IRA reductionI have finished reading the “Practical Guide” by Mr. Stecker. It wasn’t as bone-dry as he cautioned! Estate planning ‘revealed’ that I probably need to utilize my IRA assets rather than my regular assets, so that I can avoid saddling my estate with a taxable income stream. That goal of reducing my IRA balance has me preparing to set up a new SEPP.
IRA $685,800 (8606 non-qual amount $19,210)
Roth IRA $176,100
Other liquid investments $629,200
Age 55 this year (4/22/62), retired, no pension or income other than Investments
Yes I did the income stream modeling prior to retirement, and am comfortable that my assets will exceed my life-expectancy. I may be proven wrong, but that bridge has been crossed.
One of the ideas mentioned in the “guide” was new to me, Roth conversion (even though I am retired). Trying to balance converting money, while staying mostly in the 15% tax bracket may prove the most challenging. So My question becomes, “does this scenario appear reasonable?”
Fracture the IRA into
$485,000 IRA that I will use to set up SEPP.
$200,800 IRA that I can convert to existing Roth. Probably about $10,000 a year will keep me right at the edge of the 15%/25% tax margin. This fraction also serves as “dry powder” as per Mr. Stecker’s suggestions.
I recognize that the $19,210 of after tax IRA contributions is going to make the numbers messy. Some % of that getting converted into the fractured IRA, and then reducing the taxable portion of the SEPP income stream. The remaining % flowing into the Roth conversion process, and adding to the messiness of those numbers. However, unless I missed something, I can’t specify that the $19,210 is going into one of the fractured accounts, it must be spread across all existing IRA’s.
The resulting SEPP produces $23,538.06 (2.55% interest, single-life, ammortization). Starting it sometime in the next couple of months, my 1st modification date will be in 2022 (after my 59.5 birthday). So I can take the 5th payment summer of 2022… wait until at least 1 day after the modification date, and then proceed to take IRA distributions on whatever schedule seems prudent at the time. My comfort level with an IRS review is low. So I would likely wait until 2023 before I took another dollar from the IRA; avoiding the question rather than trying to explain the answer!
My existing Roth has already met the 5-yr rule. However, each of the conversions will become a rolling ladder of monies with their own 5-yr clock.
Where I started, was a SEPP using the whole existing IRA. That cash flow is $33,283. So an area where I am stymied is trying to rationalize if the “fracturing” and Roth conversion is going to complicate matters beyond what is warranted by the tax savings. Using taxed IRA money to pay for Roth conversion taxes is one of the red-flags I see mentioned. I could easily be convinced that my existing liquid investments are sufficient “dry powder”, and the KISS principle should apply. One IRA, one SEPP, and only one hurdle for handling the mixture of qualified and unqualified money coming out of the IRA.
I hope I can benefit from your comments.2017-03-29 18:16, By: Montana, IP: [18.104.22.168]
L2: IRA reductionGREAT “PLANNING DURING RETIREMENT”. That is my favorite topic for my presentations. You are “spot on”. Don’t worry about the “non-deductible IRA” effect. It is only 3% of your annual conversions or distributions ($19,000 lifetime cumulative non-deductible contributions/ $ 685,000 which we’ll assume was your 12/31/2016 balance, because you use that and not the most recent balance, whenever you start).
Don’t worry about the complexity or “messiness” of doing ROTH CONVERSIONS. It will save you 10% on your conversions, and possibly even on some or all of your ultimate RMD distributions after 70 1/2. You seem to be able to understand the additional benefit/planning of deferring your SS benefits until 70 to get a 32% increase over age 66 (or 24% over age 67) or 70% increase over age 62 (unless you have a short life expectancy). This way you can take more out of your IRA by ROTH CONVERSIONS from 59 1/2 to 70 1/2, unless you can take your SS tax free ( which is another complex calculation). USE YOUR OTHER LIQUID ASSETS FROM 59 1/2 TO 70 1/2.
It is obviously better to be taxed at 15% than 25% on your IRA whenever you take it.
MY ROTH PHILOSOPHY — Whether someone is in the 15% or 25% bracket initially, they will probably be in the same or higher bracket after 70 1/2 when they are taxed on SS benefits in addition to RMD. Therefore, it makes sense to withdraw as much as possible at 15%. In the best scenario, you would save $ 68,500 ( $ 685,000 * 10% tax rate differential) if you can take out everything at 15%. Regardless, even if you nwere in the 25% tax bracket now, and would be in the 25% tax bracket later, you benefit by even taking it out at 25% now because it would probably be taxed in that case at the same 25% now or later, which is a ‘wash”. BUT, all future income in the IRA will eventually be taxed at the same rate, but be TAX FREE in the ROTH IRA, and so would all future GROWTH be TAX FREE in the ROTH but would be taxed at 25% eventually when it is taken out by you, your spouse (if any), and your children or any other beneficiaries because they will almost definitely be in the 25% tax bracket. ( Remember, you or your surviving spouse will eventually be filing as a single taxpayer where the 25% tax bracket starts at about $ 38,000.2017-03-29 19:50, By: dlzallestaxes, IP: [22.214.171.124]
L3: IRA reductionYour design differs from Stecker’s, although that is fine as long as 23,538 will provide you with enough for your spending needs the next 5 years.
Your SEPP universe is composed onlyof the one TIRA account. The other TIRA can be converted at will, but taxes will have to be paid from other money. This is simpler than Stecker’s design.
With his design there is a TIRA and Roth IRA in the SEPP universe. Any conversions are within the plan but do not count as SEPP distributions. Since the Roth is part of the SEPP, the taxpayer has a choice of taking the SEPP distribution from any combination of the TIRA and Roth IRA. Therefore there is tax flexibility each year depending on the account selected for the SEPP distribution. Distributing recent conversions is not a problem because the 10% penalty is waived by the SEPP penalty exception. The total SEPP distribution is of course larger because the total value of the TIRA and Roth IRA is used to determine the SEPP calculation.
One development that has occurred since Stecker wrote his guide is the IRS busting a couple plans for partial distributions. The first of those was in 2007 (PLR 2007 20023). The IRS Reg that addresses conversions within a SEPP seems to assume a full conversion is done, but a full conversion is quite unlikely. In your plan you do not have the partial conversion risk because the accounts involved are not part of your SEPP universe.
You are probably aware that your 5 year conversion holding periods all end at 59.5, so if you converted each year, you would probably end up with a 4,3,2,1 and no holding period respectively.
In your plan is you do a conversion, the non taxable % of that conversion due to Form 8606 TIRA basis will be the same as the non taxable % of your SEPP distribution. Your 8606 would show separate amounts for your SEPP distribution and your Roth conversion in Part I. Yes, your line 15 of Form 1040 would show values much different than your SEPP distribution. This might attract IRS attention and an inquiry, but I think you could respond easier since your distribution plan is simpler than Stecker’s. To be clear, what Stecker describes is not to be viewed as a preferred plan, just an option.2017-03-30 02:35, By: Alan S, IP: [126.96.36.199]
L4: IRA reductionThank youdlzallestaxesandAlan S for both taking the time to comment.
Alan, I did not understand that the 5 year holding period on Roth conversions ended early if I attained “retired” status at 59.5 before the hold ended. That is good information! It should make bookkeeping a bit easier in 2022.
You both assure me that my concerns about handling the ‘previously taxed’ portion of my IRA contributions won’t be too difficult. As I am not an accountant, filling out IRS 8606 has been a tax-software issue for me in the past. I can’t currently follow your specifics, but I take your general assurances as comfort that when I have the SEPP distribution forms (1099R) and conversion forms in hand… I should be able to work my way through it and enter the appropriate numbers in the software boxes. While I am not opposed to using an accountant to do tax prep for complex situations, this site makes it clear that most accountants would be equally inexperienced with these transactions. At least I know my motivations for spending the effort to get it right!
Alan, you make a statement that I need to make certain I understand; “The other TIRA can be converted at will, but taxes will have to be paid from other money.” OK, I now have a small IRA (separate account number) that I am not using for my SEPP plan. I am converting some money from the small IRA into an existing Roth IRA each year. I believe you are saying that I can’t pay the taxes due for the conversion, out of the conversion proceeds themselves. If that was your point, I do understand.2017-03-30 15:54, By: Montana, IP: [188.8.131.52]
L5: IRA reductionIn general, ROTH CONVERSIONS work best when the taxes due on the conversion is paid with money outside of the IRA accounts. If you have to take more money out of an IRA to use to pay the taxes, it becomes an upward spiral of “grossing up” the distribution. For example, if you need $12,000 from an IRA, you have to take $ 16,000 in order to have the $4,000 you’ll need for taxes. Or, you can have $ 4,000 withheld by the IRA plan which it will send to the IRS, and you will get $ 12,000 but report both the $ 16,000 gross amount and the $ 4,000 tax withholding on your tax return. Usually, with ROTH CONVERSIONS people do not withhold taxes. They convert a certain amount, and then send a check from their non-retirement account to the IRS as an Estimated tax, or when they file their taxes, depending upon their tax situation.2017-03-30 16:19, By: dlzallestaxes, IP: [184.108.40.206]