Taxes, taxes and more taxes!!

My last week has been consumed by a nonstop marathon of tax calculations. The name of the game is smoothing out taxable distributions from tax-deferred accounts to avoid large lump-sum distributions which would put DH and me into a higher tax bracket (and potentially cause IRMAA to increase our Medicare charges).

DH was born in 1952 and I was born in 1953. We both have IRAs and DH has a 401(k) from his working years. The current tax law states that Required Minimum Distributions (RMDs) must begin at age 72, with the distribution allowed until April of the year following the 72nd birthday. For DH, that would be 1Q2025. For me, that would be 1Q2026. I have been gradually recharacterizing my Traditional IRA to a Roth IRA (and paying taxes) for several years.

In addition, I have a substantial quantity of I-Bonds which I bought in 2001 (paying inflation + 3%). They will mature in 2031. The interest from the I-Bonds is tax-deferred. I thought that I would hold them to maturity and then gradually cash them in, gradually spreading the amount through the 2030s (assuming I live that long).

Last week, my highly-respected friend, aj485, told me that I was mistaken. The rule (which I was not aware of) says that, upon maturity of savings bonds, the government will pay all interest in a lump sum. There is no option for the owner to hold the bonds after maturity (without accruing further interest) and gradually pay out the interest that had accrued from prior years. Furthermore, all the bonds must be treated the same – if interest on one is paid, they must all be paid at once and then continue to be paid every year.

Yikes!!!

Without going into detail, I spent the last few days building spreadsheets and running what-if scenarios of distributing IRAs and the interest from the savings bonds held by me and 3 trusts. Each trust can be treated as a separate owner.

I will be paying the taxes from non-tax-deferred accounts to avoid distributions from the tax-deferred accounts.

I would like to express my sincere gratitude to aj485 since she has saved me tens of thousands of dollars in taxes.

A note to everyone else: it pays to start thinking about distributions and taxes many years in advance of required distributions.

Wendy

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A note to everyone else: it pays to start thinking about distributions and taxes many years in advance of required distributions.

That crossed my mind at 59 1/2. Reasoning that the more I take out sooner, the smaller the RMDs will be later, so started taking distributions as soon as I could, to minimize future RMDs to manage taxable income.

Steve

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Reasoning that the more I take out sooner, the smaller the RMDs will be later, so started taking distributions as soon as I could, to minimize future RMDs to manage taxable income.

Sure, but if you didn’t need the money you took from the TIRAs, you could have also minimized future RMDs by doing Roth Conversions instead of just taking the money out. Further, if you were able to pay the taxes from a taxable account, converting ALL of the money to Roth and not having taxes pulled from it, its tantamount to being able to make a Roth contribution for the amount of taxes you pay. Then the funds you converted to a Roth would be able to compound/appreciate tax free. That’s better than in the taxable account any day.

Note that if you do the withholding free conversion, make sure to have enough taxes withheld during the year from other activities or in payment of estimated taxes. Also, consider not depleting your tax deferred TIRAs fully, given that as you get older your medical expenses will likely go up, and you may be able to claim it against RMD income.

Many, many moving parts. I congratulate Wendy for taking it on. Run your data and question the truisms you read like “You either pay taxes now or you pay later, no difference.” We would have definitely paid more later, even assuming something did not happen to one of us, leaving us to file single instead of MFJ.

IP

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but if you didn’t need the money you took from the TIRAs, you could have also minimized future RMDs by doing Roth Conversion

I had not considered that move, mostly because the last thing I need is another account to manage. If I did a conversion every year, I would need to pay the tax out of the divi income from my cash account, a big chunk of which is tax free. Now, I gather up the divis collected for the year, and buy something else that pays more divis.

The best move would have been to entirely roll the IRA into a Roth in the late 90s, when the pile was still in the mid 5 figures, but can’t jump in the Wabac machine for a do-over now.

Of course, rules change.

Just as I became eligible for penalty-free distributions from my IRA, Michigan started taxing IRA distributions as earned income, to help pay for tax cuts for the “JCs”.

Would not put it past the “leaders and statesmen” in DC, having discovered that the Trillion dollar deficits have not vanished as promised following tax cuts for the “JCs”, to tax distributions from a Roth, using the same formula for calculating tax-exempt distributions from a conventional IRA from non-deductable contributions. (form 8606, another bookkeeping headache I gained by trying to maximize retirement savings)

I’m more inclined to KISS

Steve

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If I did a conversion every year, I would need to pay the tax out of the divi income from my cash account, a big chunk of which is tax free. Now, I gather up the divis collected for the year, and buy something else that pays more divis.

All else being equal, you may still have been better off to do the conversion because all the income (dividends or otherwise) in the Roth is also tax free, has been tax free for longer than your dividends have been tax free, and such accounts are likely owned by more people or at least people with deeper pockets (i.e. more institutional resistance to a rules change).

Would not put it past the “leaders and statesmen” in DC, having discovered that the Trillion dollar deficits have not vanished as promised following tax cuts for the “JCs”, to tax distributions from a Roth,

I think you are at far greater risk of your dividends being taxed at a higher rate than Roths losing what makes them desirable. Additionally, few will have contribution and conversion records going back 20+ years to even begin to accurately determine what were contributions vs gains - especially on Roth 401ks that have been closed and rolled over. Your dividends are a far easier target.

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I’m more inclined to KISS

Steve

Me to, closed my trading account and loaded everything into our two TFSA (tax free) accounts. Bought nothing but Canadian high dividend payers. When the dividends turn to cash in the account I add to current positions or perhaps buy something new. I recently added SU.to (Suncor) +4.82% AIT today. There are no taxes owing when you sell shares in TFSA accounts and in the event of one family member toodling off the planet you get a one time opportunity to combine the two accounts into one with no taxes owed.

Of course it took a long time to build up tax free space with annual limits on how much you can contribute.

Tim

https://www.wealthsimple.com/en-ca/learn/tfsa-limit?utm_term…

All else being equal, you may still have been better off to do the conversion because all the income (dividends or otherwise) in the Roth is also tax free,

You’re probably right, if I was willing to deal with yet another account to manage.

and such accounts are likely owned by more people or at least people with deeper pockets (i.e. more institutional resistance to a rules change)…Your dividends are a far easier target.

Divis and cap gains didn’t receive their special tax treatment by accident. When Michigan had to pay for two rounds of tax cuts for the “JCs”, it was the people with IRAs and pensions that they attacked. The Gov that entered office after the tax on IRAs was levied has now proposed phasing that tax out. “Oh no!” cry the opposition in the legislature, “we need to cut corporate taxes instead, because that will create jobs”.

Additionally, few will have contribution and conversion records going back 20+ years to even begin to accurately determine what were contributions vs gains

I have all my tax records, going back to when I first received taxable income, about 50 years. And I kept records, to the penny, of non-deductable IRA contributions from the late 90s, which I am now unwinding, a few dollars at a time, via form 8606.

I doubt the tax man would give one whit if some people have sloppy records. Actually, those who suddenly rediscover “fiscal responsibility” might like it, because, being unable to prove their cost basis, everything withdrawn would be taxable, just like my uncle, who bought AT&T by payroll deduction from the 50s through the 70s. As if all the divestitures and remergers did not confuse the situation enough, he didn’t keep one scrap of cost basis information. I know, I looked, after he died. If anyone cries about not having the records, they will get a lecture on “personal responsibility” from the “leaders and statesmen”.

Steve

I have not done it but one thing you might want to research is that you can apparently roll an iBond into a 529 plan for someone like a grandkid and not have to pay taxes on it.

If that fits into your plans somewhere you might consider doing that just before they mature.

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I have 4 EE Bonds issued 10/2003, each reaches face value in 2023, 20yrs. Final maturity is 2033, 30yrs, but I don’t plan to hold them that long.

I had planned to begin cashing one each year from 10/2023 thru 10/2026, each for face value plus any additional interest accrued after they reach face value in 10/2023.

Wendy:
Last week, my highly-respected friend, aj485, told me that I was mistaken. The rule (which I was not aware of) says that, upon maturity of savings bonds, the government will pay all interest in a lump sum. There is no option for the owner to hold the bonds after maturity (without accruing further interest) and gradually pay out the interest that had accrued from prior years. Furthermore, all the bonds must be treated the same – if interest on one is paid, they must all be paid at once and then continue to be paid every year.

I have read that at final maturity, in 30 years when interest stops and must be reported to the IRS, the income tax on the interest must be paid. I am hoping that Wendy’s description does not apply to bonds that have reached face value, but not final maturity. I have not read anything that says that.

JG4

<I have read that at final maturity, in 30 years when interest stops and must be reported to the IRS, the income tax on the interest must be paid. I am hoping that Wendy’s description does not apply to bonds that have reached face value, but not final maturity. I have not read anything that says that.>

JG4, post this question on the Tax Strategies board. Better to find out the real answer while you still have plenty of time to figure out what to do.

https://discussion.fool.com/tax-strategies-100155.aspx?mid=35045…

Wendy

In addition, I have a substantial quantity of I-Bonds which I bought in 2001 (paying inflation + 3%). They will mature in 2031. The interest from the I-Bonds is tax-deferred. I thought that I would hold them to maturity and then gradually cash them in, gradually spreading the amount through the 2030s (assuming I live that long).

I think you also have the option to pay taxes on I-bond interest as it accrues (it accrues twice each year) rather than in the year it is paid (at maturity). The vast majority of people do not do this, of course, but instead pay taxes when they cash them in or when they mature. This will affect me as well, but I see no way around it … there will be a substantial “bulge” of income (2030 and 2031 could potentially have an extra $100k of reported interest) in the years that my old I-bonds mature. That essentially blows up much of 2030 and 2031 tax planning!

I am not sure if you can choose how much of total accrued interest to pay taxes on. But if you can, you can “use up” a lower tax bracket (similar to the way people use the current lower brackets for Roth conversions) now in the assumption that when RMDs begin, you will not be in those lower tax brackets anymore. Also once you start paying taxes on accrued interest, you can’t stop, for ALL your savings bonds. So it requires a heck of a lot of future calculations, 8 years worth in this case! And, of course, tax law can and will change over 8 years.

https://www.treasurydirect.gov/indiv/research/indepth/ibonds…

You may, however, choose to report the interest every year.