I wrote in this post that it was obvious to me that one should take Social Security (SS) early. I’ve changed my mind. I recommend that you wait to take Social Security later. Wait to age 70 to get the maximum benefit.

 

Happiness in retirement is a safe amount you have to spend each year – an amount of “pay” know you will always receive for the rest of your life.

 

1. You get more total “safe pay” – happiness – while you are alive from the added 8% pay per year that you get by waiting to take Social Security.

 

 2. You keep more of your gross pay: you pay less taxes. When you are no longer working and before you start SS, distributions from your traditional IRA fill buckets that start in the 10% and 12% marginal tax rate. Once you start on SS, those two buckets jump by 85% to 18.5% and 22.2% buckets. You want to avoid those buckets for as long as possible. Single filers who postpone – avoid those high buckets – save up to about $5,000 for each year postponed; it’s up to about $10,000 each year for married, joint filers.

 

Details:

 

== Happiness is More Pay ==

 

Let’s assume you are 69 years old and your Social Security benefit is $40,000 if you take it now. You are in good health, and you assume you’ll reach your life expectancy of 18 years. You have two options:

 

• Option 1: Postpone taking Social Security to get the maximum benefit next year. Sell $40,000 of securities for your spending this year. You will get 8% more from SS: $3,200 in constant spending power per year for the rest of your life.

 

In essence, you are buying a lifetime annuity for $40,000 that pays 8% the first year and adjusts for inflation in all years for your lifetime. This is FANTASTIC assuming you live to your life expectancy and REALLY FANTASTIC if you live longer. You will NOT get a quote for an annuity that comes close to matching this.

 

• Option 2: Take Social Security for money you will spend this year. You aren’t selling securities for your spending. You have more invested. But you’ve frozen your Social Security benefits.

 

If you assume you would earn average returns on your portfolio over your lifetime, you almost certainly will have a better return in “pay” (distributions) + residual value at death if you take SS early. I calculate that you have to earn 3.6% real return per year for this example to provide the same benefit as Social Security for your life expectancy. The expected return rate on my portfolio is 6.4%.

 

But we Nest Eggers don’t plan based on the averages. We find the amount that we should distribute from our portfolio for our spending – the $40,000 in this case – based on the assumption that we will face the Most Harmful sequence of returns in history.

 

When we run the math – use a Retirement Withdrawal Calculator – we find how fast our portfolio could deplete for a given withdrawal rate. We find it’s safe to distribute 4.75% from our portfolio for 18 years – that’s our Safe Spending Rate (SSR%. See Chapter 2 and Appendix D, Nest Egg Care). We would distribute $1,900 in constant spending power. That’s about 60% of what SS will distribute.

 

That $1,900 almost certainly will increase over time. We won’t ride a sequence of return like the Most Harmful one. But it may be many years before we recalculate to reach $3,200. (See Chapter 9, Nest Egg Care.) After ten years, I’ve recalculated to real 50% increase for Patti and me: that would get to $2,850 in this example; we’re still not at the pay SS would have provided. The difference is that we still have our initial $40,000 that we need to ensure we don’t deplete for our remaining life expectancy – now about 12 years. We’ll have some residual – maybe most all the initial $40,000 – when the last of us dies, unlike with SS: that’s kaput when we’re kaput.

 

== Happiness is Less taxes ==

 

After you’ve retired and no longer have work income, you’d like to distribute from your traditional IRA to fill up the 10% and 12% marginal tax brackets. That’s the same as converting traditional to Roth at the 10% or 12% marginal rate and immediately withdrawing from Roth for your spending. You’d would have LOVED to have converted at 10% and 12%  when you were working.

 

 

Once you start on Social Security, those two buckets disappear. Those two brackets jump by 85% to 18.5% and 22.2% effective tax rates. That jump is from the quirky formula that increases $.85 of Social Security that is taxed for every $1 of distribution from your traditional IRA.  See here.

 

Depending on how much of the 10% and 12% buckets you can fill –and not the 18.5% or 22.2% buckets – single filers save up to $5,000 for each year that they postpone. Married, joint filers save up to $10,000.

 

 

Conclusion. Do not take Social Security (SS) early – wait to gain the 8% increase in benefit per year. Wait until age 70 to start SS. You will be happier because you will have measurably more total “pay” from your SS benefits in your lifetime than you would if you took it early. You also save up to $5,000 (single filer) or $10,000 (married, joint filers) in taxes for each year that you delay SS. Distribute from your traditional IRA for your spending before age 70. Don’t use SS. Fill up the buckets in the 10% and 12% marginal tax brackets; that’s the same effect as converting to Roth at those rates, and you would have LOVED to be able to do that when you were working. Avoid the 18.5% and 22.2% buckets that replace them once you start SS.

I like arranging the most recent calendar year returns in the 3 by 3 matrix of the Investment Style Box. I get a snapshot of what outperformed and what underperformed the US stock market as a whole. This post shows ~20% real return for US stocks. That’s  about triple the long-run average return of ~7% real return per year. Large Cap Growth stocks trounced all other eight squares in the matrix. Patti and I hold a Total Market Index fund, and it handily beat the returns in seven of the nine boxes. The correct tactic is to Keep it Simple. Don’t try to tilt your portfolio overweight a sector. The winning tactic is to hold a bland, Total Market Index fund.

 

Details:

 

• The real return for US stocks of +20% this year is on top of the +22% real return last year. We needed that, since the -24% real decline in 2022 was the fourth worst in my lifetime. We now have ~10% more in real portfolio value than at the end of 2021. Historically, that’s a fast recovery from an annual decline that deep. The average real return rate over the last five years is 9.2% per year.

 

 

• Large Cap Growth trounced every other sector; it led all but one other sector by more than 16 percentage points. The returns for Large Cap blend will be similar to an S&P 500 index fund, and that outperformed a total market fund because the returns of ~3,500 mid and small cap stocks lagged those largest 500.

 

 

• The ONLY way to match the return for the total market this year was to hold enough of Large Cap Growth stocks. If you tilted your portfolio to hold less than what the total market index held, you fell short – and perhaps far short – of matching the return of a Total Market index fund.

 

Large Cap Growth has been the obvious performer over the past five, ten and 15 years. Essentially, it’s the one box of nine that outperformed the Total Market. Over the past ten years, seven underperformed badly: two lagged by ~30%; another four lagged by more than 20% in dollar return. This tells me to NEVER try to tilt to a guess of to the boxes I might think will outperform.

 

Even more details:

 

The columns in the Style Box are Value, Blend, and Growth stocks and the rows are Large-Capitalization (Cap), Mid-Cap, and Small-Cap stocks. The nine boxes in the 3 by 3 matrix aren’t equal in market value of the stocks they hold. The row of Large-Cap represents about 80% of the total value of all US stocks. I use Vanguard index funds with tiny expense ratios for the returns for each box.

 

image

 

For reference, I’ve displayed the Style Box before: for the years 2017, 2018, 2019, 2020, 2021, 2022, and 2023.  

 

I also display the +23.7% return for VTSAX – the Vanguard index fund that holds all but the very smallest  all traded US stocks. (Patti and I hold the Total US Stock fund FSKAX, +23.9% in 2023.)

 

 

== The boxes for 2024 Relative to VTSAX ==

 

You HAD to hold enough of Large Cap Growth to match the market. Seven of the nine boxes lagged the total market by more than seven percentage points in return.

 

 

The same pattern is repeated for five, ten and 15 years: you had to hold enough of Large Cap growth to be close to matching the total market return.

 

 

 

One cannot predict which style will outperform in the future. History isn’t a good predictor. I’m not guessing. I’m sticking with my Total Market fund.

 

== 2024 World stocks +16.9% ==

 

The total world market stock index, MSCI All Cap World Index through December was +16.9%. US stocks are roughly 60% of the total value of all stocks in the world. MSCI index excluding the US was 5.7%. Total International Stocks (VTIAX) were +5.1% in 2023. (Patti and I own the ETF of this: VXUS = +5.1% for 2024.

 

 

Conclusion: 2024 was a terrific year for US stocks on top of a terrific 2023. The real return was ~20%. That’s ~triple the long run or expected return rate for stocks. We’ve bounced back from the debacle in 2022 and are ~10% ahead of where we were in real spending power at the end of 2021.  

 

Every year some segments of the market outperform and some to underperform. In 2024, the return for Large Cap Growth stocks trounced the other eight boxes in the 3 by 3 matrix that describes market returns. Large Cap Growth was better than Large Cap Value in 2024 by more than 16 percentage points.

 

Over a five, ten, and 15-year history, Large Cap Growth has outperformed all other styles. It’s basically the only box that has outperformed a Total Market fund.

Investopedia, Vanguard, and Schwab state that you lose after-tax earning power if you pay the taxes on a conversion from your traditional or Roth account. You can find similar advice elsewhere. I assert they are flat-out INCORRECT. When you pay the taxes from your Roth, you are SHIFTING after-tax value from traditional to Roth. You have NO LOSS of future, after-tax spending power. If you pay the taxes from non-IRA accounts, you are doing something different: you are ADDING after-tax value to your retirement accounts that winds up in your Roth.

 

Details:

 

• Investopedia: … “you shouldn’t use funds from the [traditional or Roth IRA] account[s] to pay taxes. The best way to pay the tax bill [due on the amount converted] is to use money from a different account – such as from your savings … Paying your taxes from your IRA funds instead of from a separate account will erode your future earning power.”

 

• Vanguard: [If you convert and pay the taxes from your IRA accounts,] “You’ll lose the chance for that money to compound and grow tax-free in your IRA — which means less money when you need it in retirement.”

 

• Schwab: “Using IRA funds to pay for the conversion tax could negate the benefits of converting. A better option would be paying the tax with cash on hand.” Schwab provides the same calculator as Fidelity.

 

• Fidelity’s Roth Conversion Calculator doesn’t give you the choice of paying your taxes from your Roth conversion. The model only lets you pay the taxes from current income or sales of securities in your investment account. The calculator is actually projecting the benefit of tax-free growth from adding to Roth from your taxable account. (I do not find a direct statement from Fidelity that says paying the taxes from retirement accounts lowers future after-tax spending power.)

 

I assert that these statements are flat out INCORRECT. See summary comparison here.

 

== Apples-to-Apples SHIFT ==

 

You pay the taxes from your Roth. You start with $100 in traditional (The after-tax value is $78.) and SHIFT its after-tax value to Roth: you wind up with $78 in your Roth.

 

I assume a conversion from your traditional IRA will keep you in the 22% tax bracket and that you will pay 22% tax when you finally distribute from your traditional IRA: that’s a good assumption; you really won’t pay less than this. (I ignore state taxes: I assume you pay the same state tax rate on conversion now as you would on distributions from your traditional IRA later.)

 

 

Assuming your accounts are invested in the same securities mix, both traditional and Roth grow at the same rate. Let’s say they both double in ten years. You net the same after-tax proceeds at the time of distribution. Paying your taxes from your Roth has NOT eroded ANY future spending power.

 

 

Paying the tax is painless. If you are over age 59½, transfer $100 of securities from traditional to Roth. Sell $22 of securities in your Roth and distribute/withhold that $22 for the taxes. You have an added wrinkle to get the $22 for taxes if you are under age 59½: your distribution for taxes must come from your prior Roth contribution basis. More details are in this post.

 

== Not apples to apples #1 ==

 

You pay the $22 taxes from your current income. (This is VERY PAINFUL for most.) You are doing more than SHIFTING. You are ADDING $22 of after-tax value to your Roth.

 

If you are in the 22% marginal tax bracket, you earned ~$28 of current pre-tax income to net the $22 for taxes.

 

 

You started with $78 in after tax value in your traditional. You wind up with $100 of after-tax value in your Roth. You have $22 more after-tax value in your IRAs than you did before the conversion. The amount you added equals the tax you paid.

 

 

== Not apples to apples #2 ==

 

You sell securities in your investment account to pay the taxes. (This has some pain for folks under age 59½; see here.) You are ADDING $22 of after-tax value to your Roth.

 

You previously paid tax, say 22% marginal tax, to get the amount you invested. You paid 15% tax on dividends reinvested and now you’ll pay 15% tax on the long-term gain from higher price/share. For this example, I’ll assume that your long-term capital gain is 40%. Your effective tax rate is 6% (15% times 40%). To net $22, you would sell $23.40.

 

 

You did not directly contribute to Roth, but you wind up with $22 more in after-tax value in your Roth – the taxes you paid: you effectively shifted after-tax value in your taxable account to your Roth.

 

 

You immediately start to gain after-tax value from tax-free growth in your Roth: you don’t pay tax on dividends reinvested in the Roth, and you won’t pay tax on price appreciation. The initial benefit is small, but it increases over time. In this example, my spreadsheet says Roth nets you >5% more in ten years and >15% more in 25 years. The Fidelity calculator shows similar benefits that increase with time.

 

== A different amount of apples to apples #3 ==

 

You sell more from your traditional IRA to pay the taxes. I assume this added amount keeps you in the 22% marginal tax bracket. This is the same result as an apples-to-apples SHIFT, except that you are really converting ~$128 in traditional (after-tax value of $100), and then paying the ~$28 in taxes from your Roth to net $100 in the Roth.

 

 

You can distribute for taxes from your traditional without penalty if you over age 59½. But if you are under age 59½, you incur a 10% penalty from withdrawals from your traditional IRA: don’t to do this. See details here.

 

 

Conclusion: You can find a number of sources that state you lose after-tax value from converting traditional to Roth unless you pay the taxes from a source other than your traditional or Roth IRA. I assert THIS IS NOT TRUE. You DO NOT LOSE future earning power if you pay the taxes from your IRA.

 

The simplest, correct way to SHIFT after-tax value from traditional to Roth is to pay the taxes on the conversion amount from your Roth: this is easy to do if you are over age 59½; you have an added wrinkle or constraint if you are under age 59½: you must pay the tax out of your Roth contribution basis – the cumulative amount you contributed to Roth in the past.

 

If you use current income or sales of securities to pay the tax (painful for most) you are doing something different. You are ADDING after-tax value to your Roth.

I am on the track to convert some traditional to Roth EVERY YEAR. I want to lessen the bad tax effects of RMD from our traditional IRA. This post provides a spreadsheet you can use to judge how much you should convert this year: one for single filer and one for married, joint filers. These are closely related to the spreadsheets I provided in this post.

 

I’ll get the year-end dividend distributions for our funds and ETFs in our taxable account today and next Friday. I’ll soon have a very precise estimate of our taxable income for the year.

 

== Why convert? ==

 

I want to SHIFT after-tax value from traditional to Roth: I wind up with the same basic after-tax value in our retirement accounts, and I retain the same benefit of tax-free growth. But Patti and I will avoid higher taxes that will come from distributions from our traditional IRA: we’re all being pushed toward a higher marginal tax bracket and IRMAA tripwires because RMD increases dramatically over time. The tax effects will be worse when it is just one of us alive. Also, our heirs will keep more from Roth than traditional. See more detail here.

 

I’m also lowering the time and effort that I spend on detailed tax planning each year – lessening the headache I get every year in November and December.

 

== How much to convert? ==

 

The spreadsheet calculates how much you can convert and stay in the 22% bracket and not cross the next IRMAA tripwire. My estimate of the IRMAA tripwires applicable to your 2024 tax return is here. My estimate includes an inflation adjustment for the tripwires finalized in November; those look back at your 2023 return for IRMAA this upcoming calendar year. Lower my estimates to the present table that makes you more comfortable.

 

== How to convert? ==

 

I describe the steps in this post. You are SHIFTING after tax value in your traditional IRA to Roth. At the 22% marginal rate, $100 in traditional has the same after-tax value as $78 in Roth. Both grow tax-free in the future. Both net the same amount after taxes when you distribute for your spending:

 

Your target is to SHIFT $100 from traditional to Roth and to wind up with $78 in Roth. You can do this easily if you are over age 59½; you immediately distribute from your “conversion Roth” for the taxes. You have an added wrinkle if you are younger than age 59½. You “convert” $100 to Roth and distribute $22 from your prior Roth contribution basis for taxes.

 

 

Conclusion: I now am routinely converting some traditional to Roth each year. I am converting in the 22% marginal tax bracket, and I make sure I don’t stumble over an IRMAA tripwire. When I convert, I pay the taxes from the amount from my Roth – from the amount I transferred from my traditional IRA. My result is the same after-tax value I had before the shift. This post provides a spreadsheet that calculates how much you can convert and stay in the 22% marginal bracket and not cross the next IRMAA tripwire.

Last week I recalculated to a real increase in our Safe Spending Amount (SSA) for the upcoming calendar year (see Chapters 2 and 9, [NEC]). My post included a pdf of a detailed spreadsheet that shows ten years of recalculation of our SSA. This post contains a “short form” spreadsheet you can download: once you’ve set up the parameters for the first year and your appropriate Safe Spending Rate (SSR%; Chapter 2, NEC) for the following year, you have to enter five numbers next December 1: you will find if you Recalculate to a real increase in your Safe Spending Amount (SSA) for spending for 2026.

 

== Two versions ==

 

• First version. You calculated to a real increase in your SSA as Patti and I did. The short form from last year showed 3% real increase in our SSA. That matches the detail on the long form from last week’s post. This pdf may be easier to read.

 

 

You are starting on a “new plan.” Patti and I jump from following a sequence that started with 5.05% SSR% (5.05% constant dollar withdrawal amount) and we start anew, in effect, and now ride a sequence of returns that uses this year’s age-applicable 5.50% SSR%.

 

You don’t need to add another column to the table you used last year (although you could). You can start a sheet that reflects this new ride. If you start this new sheet on the basis of $1,000,000 starting investment portfolio, you’d update your multiplier (Chapter 1, NEC). Your calculation at the end of this year will tell you if this sequence is potentially a MOST HARMFUL sequence or not.

 

• Second version. You continue to use your current sheet. You use this sheet because you DID NOT recalculate to a real increase in your SSA: perhaps your SSR% did not change as much as ours did over the three years and/or your mix of bonds was greater than ours; bonds have badly lagged stocks and your total portfolio returns were lower if you have more bonds than we do.

 

This version adds a fifth column to the form for last year. If you don’t calculate to a real increase next year, you’ll add another column.

 

== Double-check life expectancy and SSR% ==

 

I use Social Security’s (SS’s) life expectancy calculator to get Patti’s years of life expectancy. SS uses an algorithm that predicts future life expectancy. Life expectancy typically increases when they run the algorithm. I found this year that life expectancies for Patti in future years changed slightly. When I round Patti’s years of life expectancy to whole years, her life-expectancy years increased by one year in one or two cases in the future. That translates to a slower increase in age-applicable Safe Spending Rates (SSR%s. Table in Appendix D, NEC).

 

== Gain for a real increase next year? ==

 

I can calculate that Patti and I need a +5.8% real increase in our portfolio to calculate to a real increase for spending in 2026. Our SSR% will not change which means we have to earn back more than we withdrew. (In some years, you are aided because your SSR% increases; you don’t have to earn back all that you withdrew to calculate to a real increase in your SSA. You can use this spreadsheet if your SSR% changes.)

 

 

 

Conclusion. In December – just after I get the 12-month returns ending November 30 from the Morningstar site – I calculate to see if Patti and I earned a real increase in our Safe Spending Amount (SSA) for the upcoming year. I showed the history of ten years of calculations in the post last week. This week I provide a simpler, short form calculation spreadsheet that shows our calculation for this year, and I set up it up for the calculation next year. You can download this simpler spreadsheet for your calculation.

I revised the spreadsheets for tax planning that I included in this post two weeks ago. I corrected the math that calculates the taxable gain on sale of taxable securities. My taxable gain is much less than I previously calculated. These are the corrected sheets for single filer and married, joint filers.

 

Details:

 

Fidelity’s display of our taxable securities shows the total dollar gain (today’s price – cost basis) of shares and the “percent total gain.” I assume your broker has a similar display. That’s the gain in value relative to cost basis. If the value of my shares today is $180 and my cost basis is $100, I have a total gain of $80; my gain equals 80% of my cost basis.

 

For tax planning, I want the taxable gain on an amount sold: the gain relative to price. If I sold $180 today, my gain would be $80 or ~44% of the price. At 15% capital gain tax, my effective tax rate is 6.7%. I net 93.3% of the sales proceeds.

 

I corrected the cell to correctly translate “percent total gain” to the taxable percent of the sales proceeds. You can see more details on this spreadsheet. My taxable gain from sales will be lower. I have more room to convert traditional to Roth.

 

To be more precise, and perhaps result in lower taxable gain, I could estimate total taxable gain by adding up my cost basis of “selected shares” I wanted to sell.

Wow! Patti and I calculate to a real increase for our Safe Spending Amount for next year (SSA; Chapter 2, Nest Egg Care [NEC]. It’s small – 3% – but we’ll take it. After the steep decline in 2022, I thought it would be MANY YEARS to earn back enough for a real increase: we only went two years with no real increase. This post shows 22.1% real portfolio return in the last 12 months and 50% real increase in our SSA in ten years.

 

You should calculate to a real increase in your SSA for your spending in 2025 – or be very close to a real increase – if your portfolio mix is close to ours. You will not have done as well if you have a greater mix of bonds than we do. Stocks have recovered from their -18% real decline in 2022 and are now about 13% more than they were at the end of November 2021. Bonds are down about 15% from a similar decline in 2022 and need to climb 20% to get to where they were in November 2021.

 

 

Details:

 

My historical table assumes that Patti and I withdrew our full SSA each year. This table is not directly applicable to us, because we don’t withdraw the calculated SSA shown on the table. We now fall in the category of having “more than enough.” (Chapters 5 and 10, NEC).

 

Patti and I were happy when we started our plan with $44,000 SSA. Now we’re older and our Safe Spending Rate (SSR%, Chapter 2, NEC) is greater. If we reverted back to to our original SSA, we’d calculate that one-third of our portfolio is “more than enough” – not needed to support $44,000 real SSA ($58,000 after inflation). (Since we haven’t taken our full SSA for a several years now, our “more than enough” would be greater that this.)

 

 

If we took our calculated 50% greater SSA, we’d pay greater income taxes on sales of securities and distributions from our traditional IRA accounts for no reason.

 

== The past year ==

 

• Our real portfolio return for the 12 months ending November 30 was 22.1% – almost 3½ times the long-term, expected return – long run, historical average annual return – on our portfolio of about 6.4% real return per year: our mix applied to 7.1%/year for stocks and 2.4%/year for bonds.

 

 

== Last Ten Years ==

 

• Our SSA has increased 50% in real spending power: $44,000 per $1 million starting Investment Portfolio in December 2014 to $66,100 for this December.

 

 

• My spreadsheet starts with an assumed Initial Portfolio value of $1 million in December 2014; the sheet does not show my off-the-top Reserve of about five percent. I took our first $44,000 SSA from that $1 million Investment Portfolio. After ten years, we would have taken ~$480,000 SSA withdrawals and would have $1.2 million – 20% more in real spending power – before the withdrawal we would be taking now.

 

 

• Our real portfolio return for ten years is 6.6% per year – a bit better than the expected real return of 6.4%.

 

 

== My Task List ==

 

I describe my tasks to complete in the first days of December. One task is to rebalance as I sell; that can be an awkward: this post provides a template to help.

 

 

Conclusion: I calculate our Safe Spending Amount (SSA) for the upcoming year based on our 12-month returns ending November 30. Our 12-month real portfolio return was 22.1%. I calculated to a real increase of 3% for our SSA. I am happy. After the steep decline in 2022, I thought it would be MANY YEARS to earn back enough for a real increase: we went just two years with no real increase.

I finalized my tax plan for 2024. I altered the templates I provided in August for our situation. Patti and I know we have “more than enough” (Chapter 10, Nest Egg Care [NEC]); our Safe Spending Amount (SSA, Chapter 2, NEC) is more than we want to spend. I start with the amount I want after taxes for spending in 2025. My objective is to get to a tax bite and MAGI that I can tolerate before I take our RMD. (I withhold all taxes for the year when I take our RMDs.) My revised plan lowered taxes by 20% and MAGI by 12% from my initiale plan. I include the templates for single filer and married, joint filers.

 

 

== How I used the template ==

 

I start with the total that I want for spending after taxes. My initial entries assume our spending from our portfolio comes from two sources: RMD and sale of taxable securities. The template finds federal taxes and MAGI. I always tweak this.

 

1) The biggest lever to lower taxes and MAGI is to use QCD as a part of RMD; Patti and I normally use QCD. (We’re older than 70½.) We are happy that we can donate. We did not use QCD in 2022 when our portfolio declined steeply: our calculated “more than enough” did not look that rosy. My use of QCD means I net less for spending from RMD; I need to make that up with greater sales of taxable securities + Roth.

 

 

 

2) I can lower MAGI and taxes by selling less from taxable securities and more from Roth. Selling more Roth is a bigger lever on MAGI than taxes because the effective tax rate on the proceeds of sale of taxable securities is low. I am careful in my use of Roth. I want to make sure I have enough to always be able to sneak under a nearby IRMAA tripwire. My plan this year includes selling from Roth: I gain more breathing room so I don’t mistakenly cross the next IRMAA tripwire.

 

My final plan lowered taxes by 20% and lowered MAGI by 12% relative to my first cut of no QCD and no Roth.

 

== SHIFT traditional to Roth ==

 

It ALWAYS makes sense to SHIFT after-tax value from traditional to Roth if can convert at the 22% marginal rate – you have room to the top of  22% marginal tax bracket and a conversion won’t cross an IRMAA tripwire. You would not worry about the effects of ever-increasing RMD: crossing into to the next marginal tax bracket; and the potential pain of crossing an IRMAA tripwire.

 

The correct way to SHIFT after-tax value to Roth is to pay taxes due on the pre-tax conversion amount from your “Roth Conversion account.” (I assume you are older than 59½.) See here. The template shows your capacity to convert traditional to Roth to the top of the 22% marginal bracket.

 

Example: If I could convert 3% of my traditional to Roth this year, I have forever lowered my RMD by 3% from what it would be without the conversion. If I convert 3% every year for a number of years, I’m making a significant dent.

 

Just double-check to make sure you don’t cross an IRMAA tripwire. This simple example shows you could be paying an effective 29% tax rate, not 22%, if that happens.

 

 

== Greater QCD? ==

 

Added QCD – distributing more than RMD –  is the other option to knock down our traditional IRA and future RMD. This is obviously for those who judge they have “more than enough.” If I donate 2% of my traditional IRA as added QCD, I have forever lowered by RMD by 2% from what it would be without the added QCD.

 

 

Conclusion: I completed my tax plan for 2024. I know I have kept taxes to an “acceptable” amount and I will be under the nearest IRMAA tripwire. I know how much to withhold in taxes when I take RMD at the end of next week. My revised plan lowered taxes by 20% and IRMAA by 12% from my initial plan.

 

The template that I provide in this post is different from the one I provided in August: that one starts with the total amount you want to withdraw from your portfolio (your SSA), calculates taxes and MAGI. You get to the after-tax amount you have to spend. You can adjust where you will sell (e.g., less from taxable securities and more from Roth) to “control” taxes and MAGI and increase the after-tax amount you have for spending.

 

My template in this post starts with the total I want to spend after taxes. (We know we have “more than enough.”) It calculates how much I have to sell and calculates taxes and MAGI. I can adjust the sources of cash for spending (e.g., less table from RMD when I use QCD, more from sales of taxable securities or Roth) to “control” my taxes and MAGI.

Converting traditional to Roth can be painless: you have NO added tax to pay out of your current income; you’re paying taxes for the conversion from your Roth account. Younger folks in Save and Invest of life don’t have to use any of their take-home pay to pay the taxes due. You don’t face a decision of whether or not to convert to Roth thinking that the taxes mean you can’t spend this year on a terrific family vacation. The steps to convert depend on your age: it’s straightforward if you are over age 59½ at the time of conversion/withdrawal for taxes. You have one added step if you are under age 59½. This post describes the steps.

 

== $78 Roth = $100 traditional ==

 

Let’s make sure we agree on this: $78 in Roth has the same after-tax spending power as $100 in traditional.

 

 

I’m assuming you were in the 22% marginal tax bracket when you converted to Roth and that you will pay an effective tax rate of 22% when you would sell and distribute from your traditional IRA for your spending: you won’t pay less than 22% effective tax rate on distributions from your traditional IRAs when you are on Medicare and receiving Social Security. See here and here.

 

(I’ve ignored state taxes in this post. [I pay no tax in PA on distributions from our traditional IRAs.] You can adjust the example. If your state tax is 5% on distributions from traditional IRAs, $73 in Roth is the same as $100 in traditional.)

 

== Room to convert? ==

 

There are income limits as to how much you can contribute to your own Roth account in a year. There are no income limits on conversions of traditional to Roth. A conversion will add taxable income, and you want total ordinary income to stay in the 22% marginal bracket. The top of the 22% marginal tax bracket is pretty high. You may have an ability to convert lots of traditional to Roth.

 

 

== Summary of Rules on Distributions ==

 

You can always withdraw your contribution (cost) basis of your Roth without penalty or tax. You report all withdrawals before age 59½. The IRS wants to make sure you are not withdrawing a growth portion from your IRA.

 

If you are over age 59½, you can withdraw your conversion (cost) basis – the amount you converted – at any time without penalty or tax. You report distributions if you have not held the conversion amount for “Five Years.” Again, the IRS wants to make sure you are not withdrawing a growth portion too early.

 

 

See here for more detail on the rules governing distributions from your Roth. See here for tax reporting forms.

 

 

== Steps to convert: you are over age 59½ ==

 

In this example, you are converting $10,000 in your traditional IRA to get $7,800 in your Roth. The $10,000 you are converting keeps you in the 22% marginal bracket. If you are older and on Medicare, I assume this amount does not trip IRMAA – effectively an added tax. For clarity on the steps, I’m assuming this is your first conversion and refer to your new Roth account as your “Roth Conversion account.”

 

Steps:

 

1) You transfer shares with $10,000 of value from your traditional IRA to your Roth Conversion account. This is added taxable income and you’ll owe $2,200 in tax.

 

2) As early as the same day, you sell $2,200 of shares in this account that matches your investment mix.

 

3) As early as the following day, you distribute/transfer $2,200 to your taxable brokerage account. Your broker will ask how much of this you want to withhold as taxes. Withhold the $2,200.

 

You now have $7,800 in your Roth Conversion account, and it is invested in the exact same mix as the $10,000 was. Mission accomplished.

 

You can follow these steps and convert each year.

 

 

== Steps: you are under the age of 59½ ==

 

There’s one added step for converting from Roth if you are under age 59½. You can’t convert and immediately distribute from your Roth Conversion account for the taxes. You use another Roth account that you already have to pay the taxes due on the conversion.

 

I assume in this example that you have previously contributed a total of $10,000 to Roth. (It’s value now may be much greater.) I’ll refer to this as your “Contributed Roth” account. This account is the source for taxes due on the conversion.

 

Steps:

 

1) You transfer shares with $10,000 of value from your traditional IRA to your Roth Conversion account. This is added taxable income and you’ll owe $2,200 in tax.

 

2) You sell $2,200 of shares from your Contributed Roth account that matches your investment mix. (You could have done this at any time.)

 

3) You transfer/distribute the $2,200 to your taxable brokerage account; it’s simplest if you have your broker withhold the $2,200 for taxes.

 

You have $10,000 in your Roth Conversion account and $2,200 less in your Contributed Roth account. The net change is $7,800, and it is invested in the exact same mix as the $10,000 was. Mission accomplished.

 

Once you have waited “Five Years”, you are free to withdraw any portion of your cost basis – the $10,000 conversion amount in this example– for any reason. This $10,000 is an added source to pay taxes for other conversions.

 

 

Conclusions: Roth conversions should be painless. If you want to convert $100 from traditional IRA, you want to wind up with $78 in Roth. (You’ll at least pay 22% effective tax when retired on the distributions from traditional.) Converting can be painless since you are paying the taxes from your Roth, not from your take-home pay.

 

When you are over age 59½, you convert and immediately sell securities for taxes from this “Roth Conversion account.” Then distribute and withhold for taxes. Mission accomplished.

 

When you are under age 59½, you convert, but you sell securities for taxes from your cost basis (sum of all previous contributions) in your “Contributed Roth account.” Then distribute and withhold for taxes. Your Roth Conversion account has the full conversion value and your Contributed Roth account has less by your distribution for taxes. The net effect is the same as above. Mission accomplished.