It's what you keep

METAR is an investment board where we all try to maximize returns from our investments (commensurate with our individual risk tolerances).

But we all know that it’s what you keep that matters. With taxes due on April 15, this may be a good time to discuss taxation. (Personally, I filed our taxes weeks ago and the only taxes I’m doing recently are for volunteer Tax Aide.)

The U.S. tax code is unbelievably abstruse and constantly changing. In addition to being boosted into a higher tax bracket, a year with a high taxable income can trigger a higher fee for Medicare, called “IRMAA.” I learned about this the hard way when I converted a lump sum from my Traditional IRA to my Roth IRA.

https://www.medicare.gov/your-medicare-costs/part-b-costs

The Tax Strategies Board on TMF has excellent tax advice from highly experienced people. The amazing aj485 has saved me tens of thousands of dollars in taxes by helping me plan to spread out taxes on the interest from my I-Bonds instead of paying them at maturity.

https://discussion.fool.com/many-thanks-to-this-board-35049368.a…

https://www.nytimes.com/2022/03/25/business/taxes-vanguard-i…

**For Taxes, Where You Hold Your Investments Really Matters**

**Retirement investments that are fine in tax-sheltered accounts can generate big headaches without that protection. Vanguard’s target date funds are a case in point.**
**By Jeff Sommer, The New York Times, March 25, 2022**

**...**

**Generally speaking, once you have money for emergencies set aside in accounts you can easily access without penalties, then putting the most tax-inefficient assets in retirement accounts is the general rule of thumb...**

**For example, if you are going to invest in a taxable bond mutual fund [or hold individual bonds], it may be wise to hold it in a tax-sheltered account because bonds tend to produce a lot of income. Similarly, actively managed stock mutual funds that trade frequently may produce sizable capital gains when they sell shares.**

**On the other hand, municipal bonds are generally well-suited for taxable accounts because at least some of the income they generate typically isn’t taxed. Holding stocks directly can be tax efficient, too, because unless you sell the shares, you don’t owe capital gains taxes on them, though the dividend income is taxable. Low turnover stock index funds or exchange traded funds are often appropriate for taxable accounts, too.**

**But target date funds are different. They produce taxable income from several sources: interest income from bond holdings; dividends from stock; and, crucially, taxable capital gains distributions, especially when large numbers of investors sell the funds. When that happens, fund managers may be forced to sell underlying shares of appreciated securities and the capital gains are passed on to investors....** [end quote]

It’s also worth remembering that distributions from Traditional IRAs are taxed as ordinary income, even if the distribution included money from capital gains. On the other hand, ordinary (non-IRA) long-term capital gains and losses get special tax treatment. So it would be better to put stocks into non-IRA and bonds into IRA accounts.

People who are still working are probably in a higher tax bracket than retirees. It’s better to convert a Traditional into a Roth IRA when in a lower tax bracket.

Many retired people have large Traditional IRAs/ 401(k)s which can be gradually converted into Roth IRAs over a period of years to avoid large Required Minimum Distributions at age 72 and after. This is especially true for married retirees who may both have large Traditional IRAs.

https://www.aarp.org/work/retirement-planning/required-minim…

Before making any moves, ask on the Tax Board because the @#$%! tax code has many gotchas. For example, aj485 explained recently that it’s best to leave some money in a Traditional IRA since distributions can be tax-exempted if used for large health care expenditures while Roth distributions (on which tax has already been paid) can’t.

Wendy

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"METAR is an investment board where we all try to maximize returns from our investments (commensurate with our individual risk tolerances)."

Actually, since I’m really all set; I just enjoy the banter and the angst of others and the constant attempts to remove political discourse and the other discussions and/or arguments.

Thank you all,

JimA

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Thank you for recommending this post to our Best of feature.

Actually, since I’m really all set; I just enjoy the banter and the angst of others and the constant attempts to remove political discourse and the other discussions and/or arguments.

JimA

Dang, I think that’s where I am as well, hard to break habits isn’t it?

Got a couple weeks in a Varadero all inclusive 4 star booked, then looking for a good time to fly to California and visit the grandsons. Complicated as banker lady is changing jobs and wants to do a college scouting road trip for the genius (middle) son. No longer up for the European River cruise we cancelled when pandemic hit.

Sister on the East coast of Vancouver Island (Lantzville) is getting calls every day from Real Estate agents to sell her house. We are supposed to meet up with her in Varadero after she finishes with her charity group stuff in Havana.

I’m trying to decide between keeping the dark grey Micra (with a new set of tires) or buying something bright colored so people don’t keep trying to hit it. }};-@ It is a good city shopping and appointments car and still very low mileage but the Honda line looks good? }};-D

Oh and they actually show prices.

Tim

Tim

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Have a great trip Tim.

Oh, I’ve been through Lantzville many years ago (dive trip coming back from Powell Rive to Victoria) - tell your sister I waved and got no response so just continued on.

Jim

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Thank you for recommending this post to our Best of feature.

Have a great trip Tim.

Oh, I’ve been through Lantzville many years ago (dive trip coming back from Powell Rive to Victoria) - tell your sister I waved and got no response so just continued on.

Jim

Chuckle, no problem, hop on a bird from most airports in Canada or Mexico and you can do the Varadero Golf course? }};-D

Cuba does not stamp passports (unless you beg) and all are welcome.

Tim

https://varaderogolfclub.com/

great article, and thanks for your thoughts on RMD’s.

I’m sure you’ve noticed the hit on your current taxes from the Roth conversions.
Your current income goes up when you convert, and you’re likely to pay more for
Medicare in the years when you make the conversions, due to IRMAA.
Current tax rates will supposedly go up in a few years, but whomever is in power
will have a difficult time letting them rise.

So it definitely feels like a give/take type of thing.
But since you are doing conversions, as well as very bright people like intercst
and Aj485, then the math probably works out,although every individual case will be
slightly different.

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It’s better to convert a Traditional into a Roth IRA when in a lower tax bracket.
Or, if your Traditional IRA is in equities, when the market nosedives. I converted DH’s in March 2020 (mine about a year earlier). They’ve more than doubled in value since then. IRMAA was not a factor for us, but if it were, it would’ve been only a one-year hit.
Not that I recommend market timing, exactly, but if you’re already on a schedule to do conversions, or considering it, might want to keep an eye open for opportunities to accelerate.

…large health care expenditures…
My dad’s major Assisted Living expenses (room rate and Level of Care) are medical expenses that go on Schedule A (some trivial expenses, such as haircuts and optional activities, are not deductible).
Odd to me that the IRS considers this medical, whereas Medicare and Tricare don’t (they don’t pay any of it, it’s all private pay), but that’s another issue.
Meanwhile, the result is that Dad has owed zero taxes since going into AL.

In anticipation of having AL expenses myself, maybe I should’ve left something in my Traditional IRA, but:

  • If I follow Dad’s path, I won’t go into AL myself for another 20+ years, and who knows what the tax laws will be then,
  • I’m very much in denial about having to go into AL at all. I might move to IL in a CCRC with the idea that I’ll be lucky and able to stay in IL. :slight_smile:
  • My willingness (and probably ability) to deal with complexity drops off as I age. Calculating how much to convert without slipping into a higher marginal tax bracket, figuring out when exactly I have to take RMD’s, calculating and ensuring I take the correct required RMD amounts, figuring out where to invest those amounts assuming I don’t need/want to spend them, making Qualified Charitable Distributions instead of just contributing to good causes directly, calculating to avoid or budget for IRMAA increases, etc, …
    Eh. I’m happy I won’t have to deal with any of that, because it’s all in Roth’s now.

The amazing aj485…
Yep. Aj’s the best for explaining things clearly, completely, and accurately.

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YewGuise, thanks for sharing this useful information:
“My dad’s major Assisted Living expenses (room rate and Level of Care) are medical expenses that go on Schedule A (some trivial expenses, such as haircuts and optional activities, are not deductible).
Odd to me that the IRS considers this medical, whereas Medicare and Tricare don’t (they don’t pay any of it, it’s all private pay), but that’s another issue.
Meanwhile, the result is that Dad has owed zero taxes since going into AL.”

I’m 68 (cancer survivor) and DH is 69 (moderate COPD but still smokes). We will probably need Assisted Living (AL) within the next 5 - 10 years. (That’s being optimistic since my mother died at age 72 and DH’s dad died of COPD at age 65.)

As a breast cancer (BC) survivor with ER+ BC, the chance of living more than 20 years after diagnosis (2013) is only 20%. (Recent data shows that the 5-year mark isn’t relevant for this type of BC since mortality increased linearly with time throughout the 20-year longitudinal study.) I will be 80 years old in 2033. I’d be quite surprised to be alive at that point but it’s possible since my mother’s sister died at age 90.

We have Long-Term Care Insurance but that only kicks in for inability to do “activities of daily living” like getting out of bed, showering, etc. There’s a lot of daylight between the fitness levels needed for independent living → AL → LTCI.

I appreciate your help since your information along with aj485’s creates a paradigm shift in my way of thinking about Traditional → Roth IRA conversions.

I will now keep enough money in our Traditional IRAs to cover a few years of Assisted Living.

Thanks to YewGuise and aj485.

Wendy

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I’m sure you’ve noticed the hit on your current taxes from the Roth conversions.
Your current income goes up when you convert, and you’re likely to pay more for
Medicare in the years when you make the conversions, due to IRMAA.
Current tax rates will supposedly go up in a few years, but whomever is in power
will have a difficult time letting them rise.

We ran our own numbers a few years back, a few years before DH retired at 58. We had always maxed out IRA and 401K contributions, which were mostly pre-tax traditional as that was what we had available to us, having swallowed the truism that your tax rate will be much lower in retirement. Challenge that assumption. For those of us who save well and do decently with investments, it may not be true.

I totaled up all of DH’s tax deferred funds and put that into a returns calculator as the start point, using the number of years until RMDs were required, and used in hindsight a crazy low rate of return of 4%. I assumed no withdrawals until RMDs, because we have funds that are in a taxable account. At every step I was very conservative in my assumptions.

I took the end number from the calculator and plugged it into an RMD calculator. Realize that short a catastrophic market, RMDs go up as you get older, because you need to deplete your account in less time. Year 1 of an RMD is probable to be lower than many of the other years, though eventually you do have to catch up by taking larger and larger chunks out of your IRA.

The number that came out of the RMD calculator then got added to other income for both of us, such as anticipated SS, pensions and Inherited IRA RMDs, dividends. I then looked at the tax rate we would be paying as MFJ, using the 2017 tax tables given that the Trump tax cut expires in 2025 if no legislation is enacted to extend it or make it permanent. NOTHING HAS TO BE DONE TO RAISE TAXES IN 2025. IT IS AUTOMATIC. This greatly minimizes the chance of taxes not increasing due to politician’s choices.

The conservative rate of taxes we could expect to pay using the 2017 tax tables was 28%. Remember this used compounding at a bit more than the standard inflation rate, so doing well in the market compounds this. Additionally, if something happened to one of us, we would go from MFJ to the much higher single rate of taxation. And if we were both hit by a truck while driving down the highway, our kids would inherit the TIRAs with the need to pay taxes on the full amount in 10 years. Eldest is already at a higher tax rate than we were, which is only likely to change with marriage.

It was a no brainer for us to pay up through the 24% tax rate via Roth Conversions, particularly since we were not yet taking pensions or SS, nor eligible for Medicare, and WE PAID THE CONVERSION TAXES FROM A TAXABLE ACCOUNT, allowing the full conversion to go into the Roth, which is tantamount to a Roth contribution of that tax money. We have done that through last year, but will again re-analyze the plan for this year. DH turns 63 and there is a 2 year look back period for IIRMA, so income generated this year will set how much he pays for Medicare in 2 years.

An added benefit to the Trump taxes is the size of the tax bracket, with the 24% bracket being up to $315K, although understand you get hit with NIIT over $250K. For the reversion back to the 2017 tax rates after 2025, the 25% tax rate for MFJ is up to $153.1K, 28% rate up to $233,350 heading up to 33% tax rate through $416.7K income. So our converting up through $315K of total income was a no brainer, IMO, given the risk factors.

Given the market, and the fact that we cashed in our pensions into more TIRAs out of concern for the health of the company during Covid, the Roth conversions put no dent into our TIRAs, though the Roth’s are now much larger. Happily we have since discovered QCDs, where you can donate up to $100K of your RMD tax free to a charity. I look forward to doing that if need be. We should have a better idea by then how firmly Youngest has landed on his feet, and intend to make it an annual family project.

We are not exceptional, certainly less knowledgeable about investing than most here. We are not big spenders, good savers, and put our money to work for us. We question assumptions and verify recommendations by running our own numbers. I have been told that I set records as a kid for asking “Why?”, and grew into an adult that asked “Why not?” I had the good fortune of seeing my parents retire at 58 and at 19 set my goal to retire early. I have studied this a lot and consistently worked towards my goal. There is nothing we have done that can’t be done by others.

Always question assumptions, particularly those of other people. Accept almost nothing, beyond the love of your family and your dog, at face value.

FWIW,

IP,
briefly having a financial planner who told us we couldn’t retire early and shouldn’t do Roth conversions, changing his mind when he looked at the numbers I ran

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wow, inparadise, thanks for laying that out in detail !

intercst posted this link a while back, has some good info in it.
From the tables that list the brackets and premiums for Medicare part B, and part D, it
seems like paying IRMAA is probably a secondary consideration compared to the income tax
payments. And most people on this board are going to be paying IRMAA,
no getting around it.

https://www.fa-mag.com/news/how-wealthy-clients-can-ease-the…

“There are three types of clients with respect to IRMAA,” said Lawrence Pon, a CPA in Redwood City, Calif. “Those who will never be affected by it, those who might be affected and those who will always be affected—it’s just a question of by how much.”

“In general, surcharges on monthly premiums increase pro rata for recipients earning $91,000 to $500,000 annually (for those who file taxes as single) or $182,000 to $750,000 annually (for couples filing jointly). The maximum surcharges apply to all those who earn more than the maximum annual thresholds.”

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…seems like paying IRMAA is probably a secondary consideration compared to the income tax
payments. And most people on this board are going to be paying IRMAA,
no getting around it.

Pretty much our conclusion too. And someone pointed out on one of the retirement boards that it only impacts you for part of the first year, depending on when your birthday falls.

So much about fine tuning things like this is to not let perfect get in the way of good. Don’t let it stop you from socking it away for retirement because paying too much in taxes, while a bummer because it might be avoidable, is a first world problem. Like so many of our problems are when we look at what the folks are dealing with in Ukraine!

IP

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