How To Avoid Taxes On Retirement Income

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You should avoid taxes in retirement.  This will not be easy.  You have an investment partner and he will steal from you and take advantage of you. I won’t tell you who he is, but his nickname is Uncle Sam.

Your Uncle (IRS) is your investment partner. Unfortunately, he can rewrite the rules. Your partner has the power to increase his partnership percentage whenever he wants.

Do you want the government to tell you when to withdrawal money, how much to invest, and how much to spend each year?  If you enjoy that arrangement, congratulations.  That describes our current tax laws.

It’s All About Putting Money In

When starting out we are optimistic and naive. We pile our money into tax-friendly accounts. We tend to not consider how and when we will remove the money. That will all take care of itself in the future.

Money Nirvana

IRAs are common. Your employer likely encouraged you to take part in a 401k, 403b, and/or 457b. Contribute automatically. Payroll can send it to them before you even see your paycheck. Your employer may even contribute some also as a pension plan or matching fund.

Avoid Taxes Now

You also get a tax deduction. Every dollar you contribute to your retirement fund reduces your taxable income. Since you “make less” as reflected in a lower gross income, you will pay less tax. Your state and federal taxes are based on your income after this deduction.

Avoid Taxes & Hassles

There is even better news. The money in those tax-advantaged funds will grow and grow over years or decades. You can buy and sell anything in them whenever you want without it being a “taxable event.” No paperwork. No taxes due.

Isn’t this all a dream come true? What could ever be a downside?

Back to Reality

What is pleasant on the front end isn’t as pleasant on the back end. Uncle Sam will allow your tax-free growth, but he then gets impatient and wants his slice of the action. Tax-deferred does not equal tax-free, even though they sound similar.

Uncle Sam Wants Your Money

When does he get impatient? When you are “old enough” – per the government – to start withdrawing a large amount of your savings every year. That amount is your RMD. Required Minimum Distribution. It kicks in at age 70 ½.

This applies to your 401(k), 403(b), as well as your traditional IRA. If you aren’t expecting this, it can be quite a wakeup call.

Avoid Taxes on Unneeded Money

When I mention “RMD” to my peers or younger investors I see blank stares and confused looks. Almost no one even knows about it.

When I say that to my in-laws or other people in their seventies, I get groans and eye-rolls. They are very well aware of it. For them, it means a complex and everchanging annual calculation. It means fears of penalties for not doing it right. It means paying tax on money they don’t want or need at the time.

Goldilocks Principle: Withdrawal Just the Right Amount

Not Too Much or Too Little

You must remove just the right amount of money from your tax-deferred accounts each year. If you take out too much your social security will be taxed at a higher rate. If you don’t take out enough, you will pay a stiff penalty to the IRS.

Run the Math with Care

If you are doing your own investments, you will need to figure out how much to withdrawal. If you work with a broker or mutual fund, they will do it for you. Either way, the income will be taxable and may bump you up to a higher marginal tax rate.

For example, a 90-year-old with $1.7M would have an RMD in 2019 of $149K putting him into the 24% tax bracket. If you fail to withdrawal the money, they will take half. Yes, the fine is 50%!

Pay if you do, pay if you don’t. Your choice.

Prepare While You Are Young

This is good to know about even if you are nowhere near 70 years old. If retiring early you may want to start some early withdrawals while you are in a lower tax bracket. It is worth modeling tax scenarios with different withdrawal schedules.

The Roth IRA Advantage

Roth IRAs are a great investment option. Although you won’t get a tax deduction when contributing, you avoid taxes when removing the money later. The latter factor becomes more important as we reach our “retirement” years. To some extent, this is a bet on our own future. Will tax rates be higher in the future? Will our incomes be higher?

The United States is Broke

There are a lot of unknowns about our nation’s future. But we do know that Uncle Sam is destitute. We shifted from a creditor to a debtor nation in 1985. It didn’t take us long to become the world’s largest debtor nation. 

Our financial situation hasn’t improved since then. Both democratic and republican administrations have since worsened the situation. I see no end in sight. There is not an easy, quick fix to this fiscal disaster.

The Direction of Future Tax Rates is Clear to Me

I’m A Fortuneteller

My crystal ball tells me tax rates will be higher in the future. The U.S. owes 122 trillion dollars of unfunded liabilities. Not to mention the growing national debt and annual federal budget deficits. Our day of reckoning is coming. The rich will be the only ones able to pay more of their “fair share.”

We all feel we pay too much income tax. In reality, the marginal tax rates are currently at historic lows.

The top tax bracket in 2019 is 37% and that kicks in (for married couples) only for income above $612K. The top federal tax rate was 70% when I was little. When my father was in high school the top bracket was 90%.

Pay Less on Less Now

Based on my prediction of higher taxes I love the Roth IRA option. I expect to invest and grow the funds over time. It is better to pay now on this smaller amount rather than later on a bigger portfolio.

Does that make sense? 30% tax now on 100K is better than a 30% tax later on 500K, right? But again, I don’t think tax rates will be the same or less. They will be higher.  If tax rates increase even a percent or two in the future, the Roth bet will win big.

Leave My Backdoor Out of This

For higher income professionals we cannot contribute to a Roth IRA. It used to be that only resident physicians made so little money that they could take part in Roth IRAs at all. After 2010 we can now “convert” money into a Roth IRA. We can convert all our traditional or rollover IRA money into a Roth IRA. I did that in 2011.

We can also make ongoing contributions to a non-deductible IRA up to the maximum allowed by the IRS. In 2019 that amount is $6k per year for those under age 50, $7K for their elders.

We can then “convert” those funds into a Roth IRA no matter how high our income is. You may have heard of a “backdoor Roth IRA.” That is when you add to an IRA and then convert it to a Roth.

Avoid the RMD

There is another benefit to a Roth IRA. Roth accounts are not subject to RMD. Contributing or converting to a Roth may cost you some tax money now. But it makes sense to avoid RMD requirements and tax later. I’m thankful to JL Collins for explaining RMD in his excellent book, The Simple Path to Wealth.

Employer-Sponsored Roth Option

Some companies offer a Roth 401k. That won’t provide you with a tax deduction today but will help your future tax situation. They work a lot like a regular 401K. You won’t have to worry about making too much money to contribute to it. Route money from each paycheck to the fund. The maximum is the same as a traditional 401K.

In 2019 that amount is $19k per year for those under age 50, $25K for their elders. These after-tax dollars will grow tax-free. Later you can remove the funds tax-free.

Consider whether it makes sense for you. It is a similar decision-making process to the Roth IRA decision.

Avoid the Roth 401K RMD

The Roth 401K is subject to RMD. That is odd because the alleged reason for RMDs is the IRS wants its share of taxes due. You can’t avoid withdrawals on tax-deferred accounts forever. RMD for Roth funds makes no sense. But then again it is a government program. I guess a little nonsense should be expected.

The good news is rolling it into a Roth IRA is not a taxable event. So, I plan to roll all my Roth 401k money into my Roth IRA in the future to avoid the required distributions.

Taxable Investing

Investing outside of retirement accounts isn’t a bad option for most of us. You won’t get a tax deduction for the contribution. But there are fewer restrictions about what you do with the money. There won’t be any penalties for “early withdrawal.” There are no RMDs for taxable accounts.

Get your financial house in order. Invest in retirement accounts. You can put only so much into a retirement fund each year. You may find money left over. Those funds can go to taxable accounts. 

Cut Your Tax Bill

Be aware that interest, dividends, and capital gains may increase your annual tax bill. There are ways to avoid taxes. Long-term capital gains are taxed at a rate much lower than ordinary income. So waiting until the gain from the sale is considered “long-term” will help. Investing in broad-based index funds will reduce the fund turnover or “phantom income.”

Choose Investments Wisely

Investing in municipal bonds, I-bonds, or tax-advantaged funds reduce your taxes. You may still need to pay state income tax and capital gains tax on any municipal bond fund appreciation.  Avoid buying high-yield corporate bonds, TIPS, or REITs in these taxable accounts.

Rental Real Estate Offers Tax-Friendly Income

Become a Landlord

The IRS offers many favorable laws that help real estate investors. Rental income and appreciation taxes are lower than other investment or work income. If you sell a property at a significant gain you can still avoid paying taxes. Use a “1031 exchange” to buy another similar property.

Asset Allocation in Taxable Accounts

It is best to reallocate by adding new funds to the lower component rather than sell. For example, if you want to be 50% stocks and 50% bonds and stocks have risen.

You may end up being 60% stocks, 40% bonds. Reallocate buy adding new contributions to the bond funds. There will be no taxable gain.

Also, take advantage of “tax loss harvesting.” If you have a loss of capital (e.g. after a market correction) you can “realize” that loss. Selling after the loss helps you avoid taxes on portfolio gains.

Start an HSA

An increasing number of American workers have a high deductible health plan. There are some downsides to that, for sure. One of the upsides though is eligibility to contribute to an HSA (Health Savings Account).

The idea is to encourage workers to save for their own medical costs. The unused money will grow tax-free and can be spent on medical bills later. You can avoid taxes and get your medical bills paid. This should make health “consumers” more price-conscious. A price-sensitive population will slow the growth of medical expenses.

HSA is a Piggybank Pretending to be Medical

HSA is a Retirement Fund

Medical costs aside, you should still consider this account. There is a loophole that makes HSAs enticing. You are not required to pay your medical bills with your HSA. You can use the money as a retirement account.

Triple Tax-Advantage

Every year you can contribute thousands of dollars ($7K for a family in 2019). The contribution is pre-tax (tax deductible), unlike Roth IRA contributions. When you withdraw the money for medical expenses you avoid taxes. Thus, it has tax free growth and withdrawal like a Roth but a tax deduction on the way in like a traditional IRA.

It has the best of both worlds, which is why this is worth taking advantage of if you are eligible.

Record Medical Now and Pay Later

There are lots of other great features. You can pay your medical bills with other funds and save your medical receipts. Your HSA money then grows tax-free.  Later you can submit the receipts for reimbursement. You will avoid taxes and penalties.

Wait and Don’t Use for Medical

What if you are healthy and plan to stay that way? Well then wait until age 65 and then use it for any non-medical purpose you like. Penalty-free!

If you die, your spouse will inherit it with the same rules in place. Dependents would inherit the money with no penalty. You can invest in any funds you like – even index funds like VTSAX. Sweet, eh?

Many of the tools I outlined here can be combined.  Municipal bonds, stock index funds, Roth IRAs, Roth 401k, real estate, and an HSA can all help you avoid taxes.  How do you plan to avoid taxes on your retirement income?  What did I miss?  Other tips to share?

I am grateful to Mr. Collins for explaining much of this in his excellent book, The Simple Path to Wealth.

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  1. All solid points, WD!

    I am curious to know if you invested in the Roth 401K option throughout your career. My first six months as an attending I was doing this, but then switched to pre-tax to pound more money into my student loans. Now that they will be gone at the end of the month, I get to ask the question again.

    January 14, 2019
    • TPP,
      I’m glad you liked it.

      I didn’t have the option of a Roth 401K for much of my career. I’m not sure what I would have done. It probably depended on my situation and tax rates at the time.
      I understand the appeal of getting a current tax break from a traditional 401K. I use the Roth though. I think tax rates are quite low now. The effective rates have dropped a lot over 2018 and 2019. The top marginal rate for most doctors is 24%. That is low and that is the highest dollar tax. I think we are in a low-tax sweet spot. I’m maxing my Roth IRAs and Roth 401K every year.

      At retirement, the withdrawal from traditional retirement funds will be taxed at whatever rate Uncle Sam feels appropriate at the time. I don’t like leaving that as an unpredictable future. Also, the RMDs will require you to take out a lot of money. That will cause 50% – 85% of your social security income to become taxable.

      I do have a 457b that I also max out. That is pre-tax so I guess I do have a little “tax diversification” to hedge my bets.

      January 14, 2019
  2. Crispy Doc said:

    Eloquent, WD, but of course I expect no less from you.

    Gasem is my role model for pulling off thoughtful modeling to develop a road map for high income Roth conversions after retirement. When I pull the plug on medicine, I plan to learn from his tax modeling to see what makes the most sense for Roth converting.

    I’m also curious, after reading TPP’s comment. I imagine a Roth 401k is a retirement account to use only after you’ve won the game, but your talk about historic low tax brackets is making me reconsider. Would you have done this as a young man with little in the bank?


    Crispy Doc recently posted…How My Donor Advised Fund Made Me Less SelfishMy Profile

    January 14, 2019
    • CD,
      See my comments on TPPs question.

      I’m not sure what I would have done years ago. But if I were “young” now (wait, I’m still young!), I would still go the Roth route. Some argue the benefit of Roth is actually bigger if you start early in your earning career. If you do conversions, try to earn enough to be near the top of the 24% tax bracket. That bracket is wide and low. You can convert enough to be near the top of that bracket. You personally may be over that, but this is the advice I give most doctors who are in the 24% as their top marginal rate.

      There are lots of reasons for Roth. I think having control over your destiny (and financial predictions) is a good one. I pay tax now and I’m done with that. I don’t worry as much about inept politicians. I’m not too concerned about leaving an inheritance to my children personally. But for those who are this can be part of your estate planning. There is no tax when you leave a Roth to your children or when they remove the money.

      January 14, 2019
  3. Great summary. I was surprised my first year retired when my tax bill turned out to be zero. In fact, due to a tax credit, the IRS actually owed me money. I should have done some Roth conversions but I found out too late I had zero taxes. I learned a few lessons from having zero taxes, like it also means you get zero deductions. I wrote about these lessons here:

    Dr. Cory S. Fawcett
    Prescription for Financial Success
    Dr. Cory S. Fawcett recently posted…Becoming Debt Free with Zero SacrificeMy Profile

    January 14, 2019
    • Cory,
      Thanks for sharing. That is encouraging to hear from someone on “the other side” of retirement. Good to know it is possible to have low taxes. Nice problem to have.

      January 14, 2019
  4. When I first discovered Bogleheads and personal finance 15 years ago I was fascinated with tax advantaged accounts. I put “never pass up tax advantaged space” in my IPS.

    Between 401k, profit sharing, HSA, cash balance plan, and solo 401(k) my tax deferred space keeps expanding. While this has been a savings boon, I can’t help but wonder if I’m setting myself up for a tax Armageddon. Even with Roth conversions in my 60s, I will likely end up with larger RMDs than I need. It’s a good problem to have, but it does make me wonder if there is ever a point to pass up tax deferred space.
    Side Hustle Scrubs recently posted…The Doc LotMy Profile

    January 14, 2019
    • Side Hustle Scrubs,
      Yes, it is a nice problem to have indeed. Just too much money. Ugh. LOL.

      The RMDs can be a tax burden though. It will also reduce your social security by making it more taxable.

      My retirement funds are all Roth (except for my 457). It is a little more tricky when you have a mix of Roth and non-Roth come tax time. But it might be worth having your situation modeled out from a knowledgeable tax planner or financial advisor. Depending on your current income it might make sense to convert any amount to bring you up to the top of the 24% marginal tax bracket. See my other comments.

      I don’t think we read and write enough about all this. I’m glad this post got some people thinking. If I have $5M in Roth and real estate and other investments outside of traditional retirement accounts, I’m in much better shape than someone who has that in 401K, 403b, or traditional IRAs. They will be able to spend much less after the tax man extracts the portion he feels is “fair.” And Social Security income will be 85% taxable as well. Too few mention this when discussing “their number.”

      January 14, 2019
  5. Gasem said:

    Necessity is the mother of invention. My take is to take advantage of the various accounts in a tax diversity play and spread around the risk by engaging in the freedom to make parsimonious choices. The choices have to be made decades in advance however to have a real effect. IRA’s are groovy till they are not. IRA’s are co-owned and the government is in control of disbursement. You get to keep what the government says you can keep. IRA disbursement is progressive meaning more and more comes out each year. Ordinary income tax is progressive, meaning you get charged more and more as the income goes up. A BIG RMD is progressive squared. Bad JUJU and when you kick the bucket your ol’ Lady gets booted into an even higher tax bracket. You die and Uncle Sam climbs into bed with her WORSE JUJU. So an IRA is tax deductible and a good deal until you loose control at age 70. Then you have sucker tattooed on your forehead. How to regain control? have money in other accounts that are taxed differently. Brokerage accounts are taxed paygon, pay as you go. Your money gets taxed when you make, your dividends get taxed when you make them, you get taxed on the accumulation when you sell. Your access to your money is unrestricted and much of the tax is paid as you grow. You can turn this account into a virtual Roth by doing a technique called tax loss harvesting. I saved $120K in taxes in 2016 from tax loss harvesting I did in 2000 and forward. If I didn’t have a brokerage account I would not have had the choice. I have IRA’s and I’m Roth converting. The money I received from selling appreciated stock mixed with tax loss harvest is what I am living on while I Roth convert. The advantage is I Roth convert at the lowest marginal rate since IRA money is taxed as ordinary income. Living on cash I have NO income so all of my taxes are paid against conversion at the lowest % on the dollar. Once again the progressive nature of the tax code applies and can be optimized. My initial plan was to convert it all at the top of the 24% which generates 19 cents on the dollar tax bite. However I can convert a lower amount which generates a lower tax bill and leave some money to RMD. I’m leaving enough money to RMD that between SS and RMD I will remain in the 12% bracket for a long time like 20 years or most of my retirement. My marginal cost of conversion is 13 cents on the dollar and I leave that other 6 cents in my brokerage account merrily compounding away forever. I can control the time I spend in the 12% bracket by adjusting the AA of my IRA. Smaller rate of return = slower growth = smaller RMD and after 35 years there is still plenty of money left in the IRA to use in case of a disaster. My IRA is mostly in bonds and provides the “bond” aspect of my AA diversity across my entire portfolio. What’s the Roth for? I’ll get to that. My accounts are targeted in retirement. SS is the first out. SS annuitizes as a tax advantaged and inflation protected stream of income. It is NOT gravy, it is the reddest of meat in my plan. IRA is the second out. If SS is fillet a relatively small RMD at a low tax rate is sirloin. Once the IRA RMD’s it becomes an annuity so treat it like an annuity. By dumping some IRA into a Roth before RMD what’s left in the annuitized IRA is taxed less. My brokerage is third out. It plays back up. Along with TLH it provides a ready source of extra money and the TLH keeps the tax bite low. Being in the 12% bracket also keeps the tax bite low since in the 12% bracket cap gains are ZERO so if you’re not Mr TLH you have an alternative possibility. My WR in a normal year is 1.4% on the brokerage. If I want a new car I sell a little more, pay no cap gain and buy a car. That’s what the money is there for to buy me a car and all the hamburgers I care to eat in my dotage. These 3 accounts SS brokerage and IRA constitute my income. The Roth is not income. It is self insurance and legacy money. It’s the most valuable money I own. It grows tax free, not tax deferred and Uncle Sam is OUT OF THE PICTURE. I settled with him already. It’s already been taxed and it’s growing decade after decade. If it hits the fan and I get a cancer diagnosis with a $500K price tag Ol’ Rothie will come to my rescue and not put me out of business since my WR money is considered separately. If I die from the widow maker first my wife and then my kids get the windfall. Suits me fine, I’ll be dead. Self insurance financed mostly with interest across decades and it cost me 13 only cents on the dollar to buy the protection decades earlier, such a deal! I have a HSA but I would be wary about over funding a HSA. It’s too good a deal for a country 122T in debt. With the stroke of a pen it could be means tested and taxed especially for non medical withdrawal. One advantage is you can use HSA to pay some or most of Medicare with tax free money so I would optimize around that benefit and not over fund this account.

    You see retirement is simple! Just do it right and you have nothing to worry about. How does it go? Save 25x in low cost mutual funds… If you work through this 25 times is likely way underfunded and retirement at 30 is unlikely to ridiculous, but it gives you a rational process to actually create a bullet proof end of life with a reasonable retirement date. Great read on a poorly understood topic.

    January 14, 2019
    • Gasem,
      Thanks for the comment.

      You have great ideas. In fact, you have presented more ideas here than I have time to comment on!

      I will pick a few highlights:

      I agree with the concept of tax diversification. I have a 457 which is pre-tax and a Roth 401K which is after-tax. I have money in retirement accounts and money out of retirement accounts. I have college funds for my kids in 529 and out of 529. I don’t actually have a clear crystal ball as the picture depicted so I hedge my bets.

      I agree also with the strategy of converting up to the top of the 24% tax bracket. That is currently scheduled to expire 1/1/26 so any conversion can be spread out between now and 7 years from now. A lot of people don’t understand what a tax boon we have been given with the long bracket of 24% on top of other long even-lower brackets.

      Some put enough into traditional retirement accounts so that the RMD will fall below their $24K standard deduction. That way they won’t have taxable income from the account. That isn’t a bad idea – especially if you have no other work income.

      I don’t think there is too much risk with the HSA. Who knows what the future holds. The amounts won’t make or break a physician who is putting in a few thousand per year and it is likely (but not guaranteed) to grow tax-free and be removed tax-free. That triple tax-free option is too much to pass over in my opinion. Others have voiced a similar concern that it may be restricted for only medical in the future. If the change is made, existing accounts may be grandfathered in. That is typically how changes are made.
      But even if not, medical expenses are so high that most could still use it only for medical and be fine. Current estimates for health care costs are around 300K so too much in the HSA isn’t a big problem. Lastly, for the paranoid and healthy, you can retain all of your medical receipts from here on out. Then submit those receipts at a future date to remove the HSA funds.

      Lastly, you mentioned Uncle Sam getting into bed with the reader’s wife. I don’t think guys like that idea. I’m sure I could have made a more interesting title to this post if I used the fear that idea brings.

      January 14, 2019
  6. Gasem said:

    One other thing just because you retire does not mean you stop running the game. Fate smiled on me and I tax loss harvested 20K last year for future use. As things get spent down I re-analyze my risk and spending. The advantage of getting old is a mistake has less and less time to manifest in a portfolio disaster.

    January 14, 2019
    • Gasem,
      I’m glad you were able to use TLH to your advantage. The rules can be tricky but I’m sure you did it right.

      When we are older we have less trouble after a minor mistake, but less time to recover from a major one too. It is a double-edged sword.

      But as long as you have been learning along the way and learning from mistakes (as you obviously have) you can make less devastating errors.

      January 14, 2019
  7. GasFIRE said:

    Nice overview of the retirement tax issues. This post should be the primer before tackling Gasem’s magnum opus on the subject.Very enjoyable read.

    January 14, 2019
    • I’m glad you liked it, GasFIRE.
      I need a primer before even tackling Gasem’s comments on my blog!

      January 14, 2019
  8. Xrayvsn said:

    This is an instant classic post. Great job!

    This is something that a lot of people are going to run into problems in the future and I agree, that there is far more likely a tax hike in the future than a tax decrease. It may balance out some in the beginning (before RMD) where you will be making less so won’t be in the top tax bracket, but when the RMDs hit, it could very well push you into the top brackets (which effect social security etc).

    I plan on doing a roth conversion during my early retirement period and try to get all the money converted into ROTH. That’s another great thing about FIRE, gives you many more years to convert smartly.
    Xrayvsn recently posted…Divorce and FIRE: 47 Year Old Male With KidsMy Profile

    January 14, 2019
    • Thanks, Xrayvsn!
      Sounds like a good plan. I’m not sure what your timeframe is. Ideally, I would try to have it all converted prior to 2026 when the current lower marginal tax rates expire. After that, if Congress does nothing, rates will revert to much higher levels. And Congress is very good at doing nothing, so I would count on a tax hike then.

      January 14, 2019
  9. Dr. MB said:

    Gasem and I have eerily similar retirement plans even though I am in Canada. Broke governments exist in many countries. I also laugh when I hear folks say their government benefits are icing. We will see about that.

    Taxes will always be one’s greatest expense. Plans should be made decades in advance. Thank goodness Gasem has a blog now.

    January 14, 2019
    • Dr. MB,
      My philosophy for most things is HOPE for the best, but PLAN for the worst. If we are lucky we will have low tax rates and vibrant financial markets through our retirement years. That has happened for my in-laws. I’m not sure they would have predicted that if you asked them in the late seventies or early eighties. At that time we had high interest rates, energy crises, and high inflation. But it all is well now.

      I don’t like relying on luck and government action for my personal future.

      With some planning and pre-paying of our tax bills, we can likely bring some control of our future back into our own hands.

      Thanks for reminding me of Gasem’s blog. I need to spend more time over there. He seems to be a kindred spirit: good ideas but not a lot of marketing, self-promotion, and monetizing.

      January 15, 2019
  10. David said:

    As a cynic, I shudder to think what will happen when President Ocasio-Cortez is inaugurated in 2040. She will look at all that money in those Roth accounts and demand that those people “pay their fair share”. It will not matter to the Democratic Socialists that the Roth holders already paid taxes on it. Her quest to match Maduro stride for stride may make the Roth accounts worth less to us than we hoped for

    January 27, 2019
    • David,
      I don’t think you have to be a cynic to shudder at the thought of a Cortez administration. Talk about on-the-job-training. She has said a top marginal tax rate of 70% is the lowest one she would consider.

      My interpretation of those facts is a little different though. I see it as a reason to put even more money into the Roth bucket ASAP. Pay the tax now while rates are historically low.

      Even without a Cortez or Bernie on the horizon, rates must increase at some point. The debt and bills must be paid and it won’t be coming from poor people.

      I could see Roth accounts being phased out. Historically that means grandfathering existing investments but not allowing further funding.

      Also, with Roth, we have already paid. On traditional 401K or 403b or IRAs, no tax has been paid yet. Raising the marginal rate is the easiest way to grab Baby Boomer retirement money. Although it is possible for a government to renege on agreements and add an additional tax to Roth I suppose, the traditional accounts are already legally obligated to be taxed.

      January 27, 2019
  11. Kurt Riegner, MD said:

    Just a little reminder about the HSA.

    After age 65, funds can be used for non-medical expenses without PENALTY, but funds withdrawn for such will be taxed as ordinary income. It’s still best to try to earmark the HSA fund for medical expenses, including Medicare premiums.

    January 27, 2019
    • Yes, Dr. Riegner

      Thanks for the clarification.

      I think what I wrote was right, but I didn’t clearly explain the whole story. Tax-free is a MUCH better option than just penalty-free. Most of us will pile up enough medical expenses (for better or worse) to be able to enjoy a tax-free withdrawal. Using that money for non-medical purposes isn’t ideal or recommended. But it is still nice to know it is an option. Especially to allay the fears of those who think they will remain healthy and without many medical expenses.

      January 27, 2019
  12. Ron said:

    What are the options to reduce taxes once one is in an age bracket where RMDs are mandatory? What are the tax consequences of converting an IRA to a Roth IRA (partially) after having attained age 70 1/2? Is it “worth it” to pay a presumed penalty on an IRA withdrawal beyond the RMD for that year?

    January 29, 2019
    • Ron,

      Good question. Much depends on the specific circumstance. Although I’m a do-it-yourselfer I think this is an area where a good CPA, advisor, or tax accountant could be helpful. If you have accounts at a major mutual fund company, e.g. TIAA-CREF, you may be able to get free or affordable help through them.

      I will just make some general comments here.

      I’m aiming to help people by avoiding this. If we start planning for the withdrawal early in our careers we can take our financial future into our own hands.
      If you have already passed the RMD point realize that the M stands for the minimum. Not maximum or mean. You are free to take out more. There will be no penalty.

      IF the money is coming from a traditional IRA or 401K you will still need to pay income taxes on that extra money. It will be “ordinary income” and taxed at your top marginal rate. Does it make sense to do that now? It depends on your circumstance and your future tax rates. Some recommend taking extra withdrawals up to the point where their tax bracket increases above 22% or 24%.

      January 29, 2019
  13. ScopeMonkey said:

    Perhaps a dumb question, but if one has existing IRA’s, can you convert them ALL to a Roth IRA at once, or only 7k per year? I’m a high earner so not eligible for Roth other than backdoor, have never done before though. Have a typical 401k through practice. Thanks!

    February 14, 2019
    • ScopeMonkey,

      It isn’t a dumb question at all. The way our politicians and IRS set everything up is dumb and confusing. This is one of the most common questions I get.
      So basically we doctors could never participate in Roth investing past residency since we made more than $100K. Then after 2010 things changed. The income issue was basically removed. You can convert as much as you want.

      Although you can’t directly contribute that doesn’t really affect anything. You contribute to a non-deductible IRA and then a day or two later you can convert it all to a Roth. There is no appreciation if it was just in a money market fund. So there is no tax due when you convert it. Those were after-tax dollars.

      Converting from a traditional IRA or a 401K is a little different. There you never paid tax on that. So you will owe tax when you convert it. In general, it still may be a smart thing to do. See my post about avoiding taxes in retirement. You may not want to convert it all in one year. I usually recommend converting enough to bring you up to the top of the 24% tax bracket. That is still a low rate historically.

      February 14, 2019
      • ScopeMonkey said:

        Ok so to be clear, the TIAA Cref IRA I have back from my teaching days, worth about 25k, I can’t just convert to a Roth IRA without paying taxes on the gains (only).. right? If I don’t want to do that, then the option would be to roll that into my practice 401k plan (and other small IRA’s I have as well). Then I could contribute 7k to a new IRA for this year, and convert that directly to a Roth IRA?
        Thanks so much for the help!

        February 14, 2019
        • ScopeMonkey,
          Glad to help. I think you are getting there.

          Yes, you could put 7k into a Roth using the “backdoor” method you are describing. That assumes you are over age 50, otherwise it is 6K. You could also add a similar amount into a spouse’s IRA if that applies (even if they don’t earn money).

          If your TIAA Cref IRA is a traditional IRA (and it sounds like it is) then you will have to pay income taxes on that when you take money out. Since you never paid any tax on all that money will be taxed at ordinary income, not just capital gains.

          The only question is when do you want to pay that income tax and how much do you want to pay? Personally, I prefer to pay a relatively smaller percent sooner rather than a potentially larger percent later.

          I already have converted any traditional 401K or IRA money into Roth. Pre-paying taxes made a lot of sense for my situation. There are a lot of details in all this. I’m fine with explaining these general concepts but I can’t give you specific financial advice to act on. You may benefit from consulting a fee-based hourly financial planner for a few hours.

          February 14, 2019

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