this is a great example of how ton analyze your particular financial situation:
We are a couple of 63-year-olds who retired about three years ago, and took SS at age 62. I have always felt that financial decisions made in the ten years between when we retired and age 70.5, when we cede withdrawal and tax control to MRDs, could be significant for the rest of our lives. In particular, the multi-variable decisions of account withdrawal sequencing, Roth conversion, and SS repay/restart seemed particularly important. But what decision is “best?” I have read many books, articles, and posts that address these decisions individually, but saw nothing that I could map wholly and quantitatively to our situation. So, this post describes what we did to figure it out for us. Have any of you done something similar? Did you come to similar conclusions? OUR PORTFOLIO We have a 60/40 portfolio comprised of about 80% IRA, 15% taxable, and 5% Roth. Our living expenses require a withdrawal rate of about 3.2%. We are well within the 15% FIT bracket. Our current WD approach has been: 1. Living expenses from IRA 2. Taxes and extraordinary expenses from taxable account (for as long as it survives, then switch to Roth) 3. Convert IRA to Roth up to the top of the 15% bracket for as long as we can The reason for this approach has been to get the IRA value reduced as much as possible as fast as possible, without taking “too big” a tax bite, so that RMD amounts are reduced when they hit us forever in seven years. Quantifying “too big” was part of the purpose of this exercise. ANALYSIS I build a model to see how different scenarios would play out over the next 40 years, accounting for inflation and taxes. The model consists of an Excel workbook of five spreadsheets, each of identical structure with about 50 rows and 35 columns. The differences between the spreadsheets implement the scenarios described below. Evaluation criteria 1. Total portfolio value over time (most important) 2. Maximum Roth account value (for maximum control) 3. Minimum excess RMDs (i.e., minimum required WDs over what we needed) 4. Minimum incursion into 25% bracket over the years Criteria 3 and 4 are viewed as hedges against expected future tax increases. Scenarios - Five were chosen: 1. Current approach (described above) 2. Living expenses and taxes from taxable until exhausted, then revert to current approach, plus Roth-convert to top of 15% bracket 3. Current approach but repay SS and restart at age 66, plus Roth convert to top of 15% bracket 4. Current approach but repay SS and restart at age 70, plus Roth convert to top of 15% bracket 5. Current approach but abandon Roth conversion – just stay low in 15% bracket until age 70.5 when RMDs take control Calculations – For every year from now to age 100, the model computes the following, adjusting for inflation and investment return every year: 1. Tax brackets, deductions, exemptions 2. SSI, pension, living expenses, extraordinary expenses (cars, etc.), fed/state taxes 3. IRA withdrawals, conversions, RMDs 4. Account values (taxable, IRA, Roth, total) Economic sensitivity – To assess scenario sensitivity to economic conditions, I ran the model for three conditions: 1. Mid – 7% return, 3% inflation 2. Low – 6% return, 4% inflation 3. High – 8% return, 2% inflation CONCLUSIONS The model shows that for our specific situation: 1. Scenario number 2 is always better than our current approach. 2. It is also the best scenario of all in Mid and High economic conditions. 3. Only in Low economic conditions does SS repay/restart become best, but that takes until age 87 to happen. We will change our approach to scenario 2 and forget about SS repay/restart. For our particular situation, there seems to be a "sweet spot" in all this: 1. Spend taxable account first. Pretty common wisdom, but it only works in our situation if we also make Roth conversions. Otherwise we save taxes early, but end up with bigger IRAs at age 70.5 and bigger RMDs requiring more taxes. 2. Convert as much as possible as early as possible 3. But not over the 15% bracket 4. Because the additional taxes (nearly double the rate) take too big a bite too early 5. Making it take too long for the portfolio to recover Again, this post describes what we did to figure it out for our situation. Have any of you done something similar? Did you come to similar conclusions?