Here’s a really simplistic example of how it may help.
Lets say you have $3M in your tIRA. At 70 years of age, you will be required to take out $111K every year for 27 years due to RMD ($3,000,000/27). That is in the 25% tax bracket.
Here is way to lower that to 15%. Lets say you retire at age 55 and your income stops. You can roll over to a roth ira 74k per year and pay 15% tax for 15 years or until you reach 70 (RMD age). In this case 15 years x 74,000 is $1,110,000.
Under this scenario, the $3M is now down to $1,890,000 which is 70k RMD per year with a 15% bracket.
Basically you’ve added 15 years to your RMD - that’s why you are at the lower tax bracket. In simple terms - that is a 10% tax savings of hypothetically $300,000.
Even less, because that $50K is in the 35% bracket, so you are only saving 4.6%, or $2300 or so.
What are you living on from 55 to 70 if your income stops? Other savings? That means you’ve plied up well over a million outside of retirement accounts… nice. If it’s other income you likely have to pay taxes on it, pushing more of the conversion into a higher tax bracket.
Plus, only $36K of that $111K distribution would be in the 25% bracket, the rest is in the 15% bracket. So I think you have far overestimated the tax savings.
If your net worth is closing in on $5mil, then having a bunch be in a Roth may make sense for estate planning purposes. And if you’ve accumulated $5mil, your lifestyle likely requires more than $75K/year. So I don’t feel like this is a realistic example.
As far as waiting to be in the lower tax bracket to convert to a Roth, I think that like everything…it depends.
So if you don’t have to wait very long to convert, you know that soon you are going to be in a way lower tax bracket and you are going to move from a high tax state to a zero/low cost state, yes it would be worth waiting awhile to convert.
However, if the value of your IRA is generally going up every year, waiting many years to convert could be a bad idea. If it’s a very large amount of money, it might generate the highest possible tax bracket anyways. Give you an example of a conversion we did. Converted a Roth when the value was about $145K in 2010. The value of that Roth is now about 360K. Even if we had gone into a lower tax bracket converting it five years later, we would be paying taxes on a far larger amount of money.
I think ideally one could save money by converting in a year they made as little income as possible (whether retirement, shuffling income from one year to the next, taking a break between jobs). Do this while moving to a low cost state, when the market takes a plunge, as soon as possible before your account increases in value.
And if you can do all this while standing on one foot, juggling four balls, and balancing a wine glass on a fat butt like Kim Kardashians, I will be highly impressed!
Your example in #4700 has really clarified (for me, at least) the calculations and comparisons. Can you direct to a good online calculator or other relevant resource?
So you are saying, convert some to a Roth and then immediately withdraw that amount to live on? That’s an interesting idea. It’s a sneaky way to do early withdrawals without being locked into a fixed amount at age 55.
At 59.5, it seems pointless because at that point you can make withdrawals without penalty from the IRA. RMDs aren’t required until 70.5 so you could take out any amount you wish.
"I guess the hardest thing for us to do is “keeping EVERY bill and receipt for the next few months to get a better handle on current spending.” - No need to go that route. You may be able to simply calculate net income minus annual savings to determine annual “expenses”.
For us there were too many factors of money going out (college) and coming in. So I’ve done monthly tracking of “outflow” at an aggregate level. Each month after balancing the checkbook I take a few minutes to tally and record three credit union categories:
autopay deductions (incl mortgage) / direct payments (incl Visa)
checks
cash withdrawals
I’ve noted costs for college and new car, but I excluded from the tally
In retirement, we’ll also need to factor in extra medical costs (probably more costly than the mortgage which completes in 2020) and occasional new (or used) cars.
@dadinator http://www.forbes.com/sites/ashleaebeling/2014/05/27/the-roth-ira-mistake/
Roth IRAs come with a special rule: you can withdraw the amount you’ve contributed at any time penalty-free and tax-free. The catch is that you have to have proof of how much you’ve contributed over the years. If you’re sure you’re not going to tap your account until retirement—specifically after age 59 and a half—you don’t have to bother to keep track of your contributions. All withdrawals after you’ve reached age 59 and a half and had the account at least five years are tax-free and penalty-free. But if there’s a chance you’ll need some of the money earlier, you need to pay attention because any amount you take out over and above what you’ve contributed is subject to income tax plus a 10% penalty.
@notrichenough - You are correct… I completely forgot Fed taxes are graduated. It is about half. Thanks.
@attorneymother - I just used an EXCEL spreadsheet for that hypothetical example.
One shorthand way to keep track of expenses is to charge all of your groceries with on CC and and pay check or anoher CC for you other expenses. It’s really not that bad to do and actually has you think about your expenses instead of just assuming there is nothing you can do about them.
Some folks like an evelope method–use an envelope for each different category each month and put cash into each. When it runs low or out, you have to figure out how to juggle with another envelope or wait until next month.
When I was in college and law school, I wrote down EVERY expense on a file card–new card each week. I was able to track my expenses within $.10. I didn’t consciously change my spending, but did think about if I REALLY wanted to spend because I knew I’d have to put it on the file card. Since those days, only have a hazy idea of our spending and expenses, but know they are significantly below our income so am not too concerned.
For families (like us) that charge a lot of their expense on CC, it’s helpful to get annual summary. Then you can quickly see the trends. This was a good reminder to me - I just printed out our 2014 Year End summary from Chase website.
I think our goal after retirement is to have our annual income (after exemptions and deduction) to be within the 15% tax rate bracket. I think we should be able to live with up to $74,900 annual income after exemptions and deduction. (would be extremely happy if we can have that much.)
The discussions about million dollars in Roth or tIRA are irrelevant to us. We are not in that league.
If you have a Roth IRA with contributions that didn’t come from a rollover conversion, those are regular, original contributions. You have the most flexibility withdrawing original contributions because you can take them out at any time with no taxes or penalties.
However, the rules are different for funds in a Roth IRA that were rolled over and converted. To withdraw rollover conversions without taxes or penalties, there is a 5-year waiting period that starts on January 1 of the tax year you convert.
And no matter whether you have original contributions or conversions in your Roth IRA, you can’t withdraw the earnings on those funds without paying income tax plus the 10% early withdrawal penalty if you’re younger than age 59½. (Remember that you paid tax on the contributions or conversions—but not on the earnings or growth in the account.)
A lot of people aren’t aware that there are some exceptions to withdrawing from an IRA without a penalty so I thought I’d copy and paste it…
Exceptions to the Early Withdrawal Penalty
There are several exceptions to the rules that allow you to take early distributions from a traditional or Roth IRA at any time without getting hit with the 10% penalty. They include:
Disability
Medical expenses
Taking distributions as an annuity
Costs to buy, build, or remodel a first home
Higher education expenses
(This is not a complete list so refer to IRS Publication 590, Individual Retirement Arrangements for complete information.)
Yes, the regular credit card reports are a good quick eyeball of what we have been spending on for the month. We mostly use credit cards and each have a small amount of cash each month. We also write a very few checks and have some direct payments to utlitites.
I played with this Roth IRA conversion calculator a bit. Please report back if you think it’s a reliable calculator. Understandably, its reliability is dependent on the projected tax rate in retirement.
That calculator seems ok, although it assumes that all of the converted amount would fall within the same incremental tax bracket, and all of the eventually withdrawn money would also be in the same incremental tax bracket. This is a big simplification which could change your results.
