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Bogleheads University 501 2023 - Roth Conversion and Retirement Tax Planning with Wade Pfau


Whisper Transcript | Transcript Only Page

00:00:00.000 | [ Applause ]
00:00:06.600 | Also, remember the slides, if you're having trouble seeing them
00:00:10.200 | or you just want them, they're downloadable.
00:00:12.040 | If you go to the Bogle Center website, you can click on the link
00:00:14.740 | and you can download all the slides for this presentation.
00:00:16.880 | All right, our next speaker, I have a page worth of introductory material on Wade.
00:00:24.500 | He has done so much, but I am not going to read it all to you.
00:00:27.340 | I'm going to give you a very brief summary.
00:00:29.980 | Wade has a PhD, he has a CFA, he's the founder of Retirement Researcher,
00:00:34.820 | which is an educational resource for individuals and financial advisors
00:00:38.560 | on topics related to retirement income planning.
00:00:40.960 | He holds a doctorate in economics from Princeton.
00:00:44.340 | He's published more than 60 research articles.
00:00:47.020 | He's a past selectee for many, many lists of important people.
00:00:52.160 | He has contributed to Forbes and Advisor Perspectives and for the Wall Street Journal.
00:00:58.420 | He's spoken at many national conferences, including the CFA Institute,
00:01:01.720 | the CFP Board, NAPFA, et cetera, et cetera, et cetera.
00:01:05.440 | He is a return speaker here at the Bogle Heads Conference.
00:01:09.380 | He's been here several times, and is also the author of four books
00:01:12.380 | in the Retirement Researcher's Guide series.
00:01:14.100 | Wade, thank you so much for being here, and we're going to enjoy your presentation.
00:01:16.880 | >> Hey, thanks so much, Jim.
00:01:17.880 | [ Applause ]
00:01:21.300 | Thank you.
00:01:22.040 | It's great to be back at Bogle Heads, and for the next 25 minutes we're going to go
00:01:26.100 | on a rollercoaster ride, literally when you see what these tax maps look like.
00:01:29.800 | We're going to talk about tax-efficient retirement distributions.
00:01:33.080 | There is a lot of content, so I'll have the same challenge as the other speakers.
00:01:36.240 | I don't know if I'll get through all these slides or not, but let's dive into it.
00:01:39.600 | This is a big deal, what we're talking about, just being smart
00:01:42.720 | about where you take distributions from can have a significant impact on portfolio longevity
00:01:48.360 | or framed a different way on the remaining legacy value of assets at the end of retirement.
00:01:54.960 | Why is that?
00:01:56.180 | It's because we're maneuvering in the United States a progressive tax system,
00:02:00.060 | not just the fact that income tax rates increase as you get to higher income levels,
00:02:04.600 | but there's a lot of other factors that we're going to be talking about.
00:02:07.600 | And so we want to strategize around paying taxes when we can do so at a lower rate in order
00:02:13.660 | to avoid having to pay taxes later at a higher rate.
00:02:17.000 | The tax code is filled with a number of nonlinearities and traps that we have to deal with.
00:02:22.360 | The effective marginal tax rates on a dollar of income, the dollar of tax paid on the last dollar
00:02:27.160 | of income can be quite a bit higher than income tax rates, and we're not even getting
00:02:32.060 | into state income taxes, this is purely today going to be in terms of federal income taxes
00:02:36.780 | and all its related nonlinearities and traps.
00:02:40.100 | And there can be many different types of tax treatment
00:02:42.760 | in the tax code that need to be coordinated.
00:02:44.400 | So some of these nonlinearities that are relevant for what we're talking about here,
00:02:49.220 | many tax rules do connect to adjusted gross income, not taxable income.
00:02:53.380 | Itemized deductions only count when they're higher than the standard deduction.
00:02:58.220 | That's not relevant, I'm just going to be assuming the standard deduction
00:03:00.620 | for what I'm talking about today.
00:03:01.840 | But there are strategies around deduction bunching and that sort of thing as well.
00:03:05.200 | Preferential income sources, and this is an important point
00:03:08.320 | that if you haven't really thought about before, it's big.
00:03:11.320 | They stack on top of ordinary income.
00:03:13.840 | So you can easily get yourself into a situation where when you generate ordinary income,
00:03:18.660 | you're also pushing your long-term gains into a higher tax bracket at the same time.
00:03:22.520 | A dollar of income can trigger tax on Social Security benefits.
00:03:26.580 | A dollar of income can trigger higher Medicare premiums, and Mary Beth already introduced us
00:03:31.180 | to that concept earlier with those IRMA surcharges.
00:03:34.100 | A dollar of income can trigger the loss of subsidies if you're getting health insurance
00:03:38.500 | to an Affordable Care Act plan that is eligible.
00:03:41.320 | And then we have the 3.8% net investment tax as well on that investment income.
00:03:48.620 | And then the big one is that we're going to try to plan for, and what a lot of this is doing is trying
00:03:53.200 | to prepare in advance for the day that we're hit by required minimum distributions.
00:03:57.500 | They can force you to generate a lot of taxable income that you may not want,
00:04:01.020 | and that may cause all these nonlinearities to kick into effect
00:04:05.020 | so that you'll see what we're trying to avoid by planning ahead
00:04:08.480 | and getting those RMDs down before they begin.
00:04:10.660 | So simply we have total income, above the line deductions removed from that,
00:04:15.400 | give you adjusted gross income, below the line deductions or the standard deduction
00:04:19.080 | in this context will give you taxable income, and then I'm just showing this to now simplify.
00:04:24.320 | We're talking about different types of investment accounts, so taxable brokerage accounts,
00:04:27.800 | tax deferred accounts, which from now on I'll just call IRA to make it simpler,
00:04:31.920 | and then after tax or tax exempt accounts that I'll just simplify as a Roth IRA.
00:04:36.840 | So when I'm talking about all this tax planning, it's going to be your taxable account,
00:04:39.940 | your IRA, or your Roth IRA.
00:04:41.960 | Now, it could be much broader than that, but we only have 25 minutes to avoid, well,
00:04:46.920 | all these potential options, tax-efficient retirement distribution strategies.
00:04:50.940 | So the starting point, and it's not the worst thing you can do, it's reasonable,
00:04:56.480 | but we're going to show how we can do a lot better than this,
00:04:58.100 | but the conventional wisdom starting point for spending on assets
00:05:01.840 | in retirement is you spend on your taxable account first, then your tax-deferred accounts
00:05:06.980 | or your IRAs, and then your tax-exempt account you save for last, or your Roths.
00:05:11.380 | Now, that's a starting point that we're going to talk about doing better.
00:05:14.180 | Now, how can we do better?
00:05:16.640 | I'll be talking about this idea of effective marginal tax rate management.
00:05:20.500 | The idea is we're going to aim to fill up -- we're going to want to pay taxes.
00:05:24.200 | We have to pay taxes at some point.
00:05:26.060 | We're going to look for opportunities to pay them at lower rates.
00:05:29.160 | So we're going to fill up lower brackets with income and then draw from elsewhere,
00:05:33.840 | if we can set this up in advance, to avoid getting pushed
00:05:37.060 | into these higher effective marginal tax rates.
00:05:39.840 | Now, RMBs are going to be a big problem in the future.
00:05:42.120 | So we're doing a lot of this in advance of when RMBs begin.
00:05:45.060 | A part of this is going to be you end up paying taxes
00:05:48.580 | in the short-term to get long-term benefits.
00:05:50.960 | A lot of retirement income planning shares that theme.
00:05:53.920 | Short-term sacrifice can create great long-term benefits, and the biggest impacts for this
00:05:59.180 | in the tax code, they occur at a spot that's $100 a part for singles, $200 a part for couples.
00:06:05.660 | I don't know why they made this difference, why they didn't just put it in the same spot,
00:06:09.240 | but when you shift from right now 12% to 22% for ordinary income, that's a big jump
00:06:14.360 | in the taxes at these income levels, and then preferential income at about the same point is
00:06:20.220 | going to be switching from the 0% bracket to the 15% bracket.
00:06:23.580 | Then we have lots of income sources.
00:06:26.980 | I'm not really going into detail on this other than to say we've got ordinary income
00:06:31.000 | that what I'll be showing you with these tax maps will mostly relate to IRA distributions
00:06:36.100 | and then the taxable portion of Social Security.
00:06:39.260 | We have our preferential income sources, qualified dividends, and long-term capital gains
00:06:43.040 | that we may be forced to take just because if we have taxable assets,
00:06:46.220 | it's going to be kicking off qualified dividends.
00:06:48.640 | In addition to if we're selling shares of that, that will also generate long-term gains.
00:06:52.680 | And then we have non-taxable sources, which will be, for this context, the Roth IRA,
00:06:59.240 | and then the portion of Social Security that's not taxed, which we have some ability to reduce.
00:07:04.500 | We can get more of that Social Security to not be taxable by planning ahead.
00:07:09.560 | Now part of this is going to involve Roth conversions, which are IRA distributions to the Roth IRA.
00:07:15.640 | You cannot Roth convert your RMD, so that's why it becomes a lot harder to do Roth conversions
00:07:21.060 | after RMDs begin.
00:07:22.100 | We're trying to do this before RMDs.
00:07:24.380 | Ideally, we'd pay taxes from elsewhere.
00:07:26.120 | We wouldn't pay it out of the IRA.
00:07:28.220 | But it's not necessarily a huge difference if you don't have any taxable assets anymore.
00:07:32.600 | But in an ideal world, you'd be paying the taxes from somewhere else,
00:07:36.940 | not from money you're taking out of the IRA.
00:07:39.840 | You can have a big window of opportunity to do this in your 60s if you're retired and
00:07:43.640 | delaying Social Security.
00:07:45.760 | You could also be thinking ahead about potential large health bills or long-term care that's deductible,
00:07:52.660 | having some IRA money to offset that, which would be a reason to not fully convert everything.
00:07:57.640 | And then also during a market downturn, if you do have resources that are not losing value,
00:08:01.820 | that can be a good opportunity to do conversions at a lower bill.
00:08:05.380 | You get more shares moved over at a lower cost relative to before the market decline.
00:08:10.860 | Why might you want to front-load taxes?
00:08:14.180 | And this is not a political discussion at all, but just to the extent that we don't
00:08:17.780 | know what the future tax code will look like, the odds are if anything changes, it's probably
00:08:22.080 | going to be a change towards higher taxes than what we see today.
00:08:25.320 | The current legislative code is in 2026, the tax rates are going to be going up.
00:08:30.020 | And I've incorporated that into this analysis, but we never know.
00:08:33.120 | Maybe the current tax code could be made permanent, or what other changes might come along.
00:08:37.400 | Now the tax implications of a death of a spouse are pretty big, and I'll show specific tax
00:08:42.020 | maps for single individuals versus married filing jointly.
00:08:45.620 | You'll see what I'm talking about here.
00:08:47.220 | A single individual can face a much higher tax bill.
00:08:50.980 | Their spending may decline, but their overall taxes may increase, and I'll show this.
00:08:55.860 | We want to be, again, preparing in advance for required minimum distributions and the
00:08:59.540 | impacts that would have.
00:09:01.220 | And then also with the SECURE Act that passed in 2019, the old lifetime stretch on an inherited
00:09:05.820 | IRA for adult beneficiaries, adult children beneficiaries, now becomes a 10-year window.
00:09:11.380 | That could push them to take these out during high earnings years potentially, if they receive
00:09:15.860 | this inherited IRA in their 50s.
00:09:18.100 | It's not necessarily a great time for them to have to deplete that over the next 10 years.
00:09:22.660 | So helping to manage that process as well.
00:09:25.900 | Now here's a case study.
00:09:26.900 | I won't have time to go through all the details, but it's just illustrating the idea.
00:09:31.100 | This is showing how much taxes are paid every year, where the yellow is the conventional
00:09:35.620 | wisdom.
00:09:36.620 | Spend your taxable, then tax deferred, then tax exempt.
00:09:39.180 | And then the purple is the tax bills related to a more tax-efficient strategy, which I
00:09:43.460 | labeled here in a difficult way and then later realized, actually, I can make this simpler.
00:09:48.020 | This is pretty much going to be the same as you're going to manage the 15% marginal tax
00:09:51.580 | rate.
00:09:52.580 | You pay taxes whenever you can do so at 15% or less.
00:09:56.260 | So then what happens is you do face higher tax bills in your 60s.
00:10:00.460 | But by the time Social Security starts at 70, you're in a position where now RMDs are
00:10:06.340 | going to start at-- well, you do have some years where no taxes.
00:10:10.060 | Then once RMDs begin, we didn't get this aligned perfectly between the RMDs and the taxable
00:10:15.260 | part of Social Security, we do face a little bit of taxes.
00:10:18.780 | And that's going up over time because the Social Security brackets are not inflation
00:10:22.580 | adjusted, unlike everything else.
00:10:24.560 | So I'm not assuming any changes to the current law there.
00:10:27.720 | That's why taxes-- in inflation-adjusted terms, this is all inflation-adjusted purchasing
00:10:31.400 | power-- why the taxes creep up over time.
00:10:34.500 | And then we're running this plan out through age 95 with the conventional wisdom strategy.
00:10:39.900 | Their after-tax legacy is $37,000.
00:10:43.260 | With managing the 15% marginal tax rate, their after-tax legacy is about $160,000.
00:10:50.260 | So again, potentially big differences here.
00:10:52.660 | And this was a couple that had $1.5 million of investment assets at age 62.
00:10:58.640 | So let's dig into this more.
00:11:00.420 | What pitfalls-- so I'm saying, OK, let's pay taxes in advance.
00:11:03.780 | What pitfalls are there when you do that?
00:11:05.900 | Or conversely, what pitfalls can we help to avoid later when we do that?
00:11:09.660 | Well, this is the federal income tax brackets.
00:11:11.860 | Like I mentioned, they are progressive.
00:11:13.620 | As your income increases, your taxes go up.
00:11:16.900 | And you have to look at the title of each slide, because they're going to be jumping
00:11:19.980 | around.
00:11:20.980 | I'm just showing this.
00:11:21.980 | You have no Social Security benefit and no preferential income in this slide.
00:11:25.660 | So that means this is adjusted gross income.
00:11:27.940 | Later, the x-axis will change to ordinary income other than taxable Social Security.
00:11:34.180 | The way Social Security is taxed is super complicated.
00:11:37.180 | If they wanted to design something even more complicated, it makes it very hard to make
00:11:40.860 | these charts.
00:11:41.860 | So I'll be careful here.
00:11:43.220 | Here we've got adjusted gross income on horizontally.
00:11:46.460 | We have the federal income tax brackets.
00:11:49.500 | Now let's talk about what happens when we're generating more ordinary income.
00:11:54.460 | This is out of order.
00:11:55.460 | But we'll have the Social Security tax torpedo.
00:11:57.380 | We'll have this issue.
00:11:58.380 | And this is the first one, pushing preferential income into higher tax brackets, and then
00:12:02.460 | IRMA surcharges.
00:12:04.460 | And then there is the Affordable Care Act issue.
00:12:06.080 | But I'm not going to include that in these tax maps.
00:12:08.540 | I'll show you what it looks like real quick later.
00:12:12.180 | The preferential income brackets are not the same as the ordinary income brackets.
00:12:16.140 | Here's what they look like in 2023.
00:12:18.660 | Any day now, we'll probably get the 2024 numbers.
00:12:21.660 | OK, so here's a quick example of what I'm talking about, just so that it can make sense.
00:12:26.340 | The idea is your preferential income stacks on top of your ordinary income.
00:12:30.220 | So we'll take a single individual.
00:12:32.140 | They have taxable income of $44,625.
00:12:35.360 | So it's more than-- if this was the all ordinary income, they would be in the 22% bracket.
00:12:41.200 | But this is the $40,625 of ordinary income, $4,000 of long-term capital gains.
00:12:46.980 | So that $40,625 is in the 12% bracket still.
00:12:50.200 | This is a single filer.
00:12:52.400 | With their $4,000 of long-term gains, $2,000 of that still falls in the 0% preferential
00:12:58.140 | bracket.
00:12:59.140 | $2,000 of that falls in the 15% bracket.
00:13:02.960 | Now what happens if they take $1 out of their IRA?
00:13:05.660 | So they've got $1 more of ordinary income.
00:13:08.100 | That's taxed at 12%.
00:13:10.380 | But now that's changing.
00:13:12.100 | Now when you stack your preferential income on top of that, now just $1,999 is in the
00:13:17.300 | 0% bracket.
00:13:18.700 | $2,001 is now in the 15% bracket.
00:13:21.620 | So we took $1 out of the IRA.
00:13:24.080 | That's also pushing $1 preferential income into the 15% bracket.
00:13:27.860 | That's adding another 15% of taxes.
00:13:30.100 | So that's a 27% marginal tax rate.
00:13:33.760 | So now their Social Security is still zero, but they have forced $20,000 of preferential
00:13:40.080 | income qualified dividends off their brokerage account.
00:13:44.000 | Now that this is what's going to happen, we're starting to create these tax maps.
00:13:47.800 | We're going to have this range where they were in the 12% federal income bracket, but
00:13:51.200 | they're paying a 27%.
00:13:53.320 | And then later on when they're getting closer to that $250,000 threshold, they're then in
00:13:59.120 | the 24% bracket, but then another 3.8% on top of that for preferential income.
00:14:06.440 | Social Security tax torpedo.
00:14:08.600 | So up to 85% of Social Security benefits are taxable.
00:14:12.880 | I'm not going to go-- we don't have time for the whole explanation of how they're taxed.
00:14:16.160 | We'll kind of leave it at that.
00:14:17.680 | But that tax schedule was created in 1994.
00:14:20.540 | And it's not inflation adjusted, one of the rare aspects of the tax code, where every
00:14:24.640 | year more and more Americans face taxes on their Social Security benefits.
00:14:28.660 | It is a complicated process to determine what percentage of that is taxed.
00:14:32.760 | And proactive planning, though, does help to avoid the full tax torpedo.
00:14:35.840 | And that is a key aspect of tax efficiency in retirement.
00:14:39.680 | So I absolutely agree with Mary Beth that it's best for the hirer to really think seriously
00:14:43.560 | about delaying to 70.
00:14:45.560 | This is a-- but wait, there's more.
00:14:47.600 | If you're delaying until 70, you can give yourself a big opportunity to not just have
00:14:51.480 | a higher Social Security benefit, but to have less of that benefit taxed if you're doing
00:14:55.520 | tax planning in the meantime.
00:14:58.540 | And here's what this tax torpedo looks like.
00:15:01.120 | So we're moving along.
00:15:02.400 | We think we're in the 10% bracket.
00:15:04.680 | And so now we have-- this is a couple.
00:15:07.320 | They have $52,200 of Social Security.
00:15:09.480 | They have no preferential income right now.
00:15:12.000 | And now the x-axis is not adjusted gross income anymore, because it makes it a lot harder
00:15:15.720 | to do that.
00:15:16.800 | It's your ordinary income, not including taxable Social Security.
00:15:20.400 | So we're moving along.
00:15:21.400 | We're taking money out of our IRA.
00:15:22.680 | We think we're in the 10% bracket, but we're getting hit by-- this is where, if I take
00:15:27.000 | a dollar out of my IRA, $0.85 of a dollar of my Social Security is taxed.
00:15:31.920 | That's pushing me to an 18.5% tax rate.
00:15:34.920 | And then I get kicked up into the 12% bracket.
00:15:37.880 | And now $1.85 with the tax torpedo that I think I'm in the 12% bracket, but I'm being
00:15:44.240 | taxed at 22.2% when I add in the fact that this is uniquely causing Social Security to
00:15:49.280 | be taxed.
00:15:50.280 | Eventually, I get up to that 85% threshold, and I don't have to worry about it anymore.
00:15:57.520 | Now for a single person, this looks a lot worse, because the full impact of the tax
00:16:01.800 | torpedo doesn't come in the 12% bracket like with couples.
00:16:05.960 | It comes in the 22% bracket for a single person.
00:16:10.860 | And in a few years, that 12% and 22% is going to change to 15% and 25%.
00:16:16.160 | But here, they're getting hit by the full burden of the tax torpedo in the 22% bracket,
00:16:21.400 | which we're going to multiply by 1.85, because a dollar from the IRA, also then $0.85 from
00:16:26.480 | Social Security, 40.7% marginal tax rate.
00:16:32.120 | Then Irma.
00:16:33.120 | So Irma's experience-- Mary Beth did talk about this.
00:16:36.320 | When you hit certain thresholds, you got a big extra bill.
00:16:40.000 | If you're a single person, and you had this in 2023-- well, two years later-- $97,000,
00:16:48.320 | you pay your base premiums for Part B and Part D $1 more, and your base premiums are
00:16:53.840 | jumping by $937 for the year, or a 93,700% marginal tax rate on a dollar of income.
00:17:02.680 | Now if you do have a life-changing event, like retiring, but Roth conversions don't
00:17:06.440 | count as an excuse here, you can file form SSA-44 and ask not to be hit by the Irma surcharge,
00:17:13.200 | because it applies to two years later.
00:17:16.240 | You take income from this year, and then two years later is when you look at those thresholds
00:17:20.440 | and determine if you have to pay a higher tax.
00:17:24.140 | As Mary Beth noted, yesterday, these numbers-- or today-- either yesterday-- the new numbers
00:17:28.280 | are out for next year's table, but here's the 2023 table that I'll be using.
00:17:33.640 | Now we're back to a scenario where Social Security is zero, preferential income is zero,
00:17:38.440 | we're looking at taking money out of our IRA, generating ordinary income, we're moving along
00:17:42.520 | the federal income brackets, but then we start getting hit by these Irma thresholds, and
00:17:46.240 | there's five of them, and each time you hit one-- this is for a couple, so you take the
00:17:50.440 | numbers per person and multiply them by two-- an extra $1,874 in Part B and Part D premiums,
00:17:56.600 | then later $2,800, then later another $2,800, and then there's two more that are going beyond
00:18:02.340 | where this chart ended.
00:18:03.840 | So that's Irma.
00:18:06.440 | Now if you put this all together, so now we've got $52,200 of Social Security, we have $20,000
00:18:12.940 | of preferential income, and we're looking at what happens as we take money out of our
00:18:17.120 | IRA.
00:18:18.320 | And this is where, if you think ahead, why might we take money out of our IRA?
00:18:22.640 | Maybe there's R&Ds that we don't actually want to spend, but this is what it's doing
00:18:26.560 | when we combine all these factors together.
00:18:29.100 | This is what the tax map looks like.
00:18:30.680 | This is the roller coaster.
00:18:32.240 | Your effective marginal tax rate goes up and down as you're generating more income, and
00:18:36.760 | it can be a lot higher than what the federal income tax brackets look like.
00:18:41.080 | Now with a single person, again, it looks differently because that tax torpedo hits
00:18:46.580 | you in the 22% bracket, and with that preferential income, you think you're-- actually, in this
00:18:52.920 | case, so you think you're still in the 12% bracket, but when you take $1 out of 12%,
00:18:58.540 | it's pushing another $0.85 of Social Security to be taxed, and then so that's-- we're working
00:19:04.320 | our way up, but then we're also getting the preferential income stacking issue, where
00:19:08.340 | now we're pushing $1.85 into the 15% bracket.
00:19:13.020 | When you put that all together, this poor person thought they were in the 12% bracket,
00:19:17.500 | but when they take $1 out of their IRA, they're paying 49.95% as a tax rate on that dollar.
00:19:24.100 | So that's devastating.
00:19:26.820 | That's what we're trying to plan for here.
00:19:30.020 | And I don't really have time to talk about the Affordable Care Act subsidies, but this
00:19:33.260 | is-- if you treat the loss of subsidy as a marginal tax rate, this is an example of what
00:19:38.300 | it can look like.
00:19:39.300 | Now there's a lot of variables that go into it, so it's not just one of these, but right
00:19:42.500 | now, and at least through 2026, this may change in 2026.
00:19:46.460 | Once you get above the 400% federal poverty line threshold for the household, you get
00:19:52.140 | this long range where incomes can go quite high, where you're losing $0.085 per dollar
00:19:58.300 | as you're generating taxable income.
00:19:59.860 | You're losing the subsidy for your health insurance.
00:20:02.620 | OK, so how can we manage this?
00:20:05.740 | So we've got these kinds of tax maps that we're trying to figure out, what do we do
00:20:08.780 | with these?
00:20:09.780 | How can we build an effective retirement income strategy?
00:20:12.460 | Well, the way I like to think about this is, first, what could we do to generate the least
00:20:17.380 | amount of taxable income?
00:20:19.100 | And that's our starting point.
00:20:21.100 | And then can we justify increasing taxable income above that by generally then moving
00:20:26.140 | away from Roth distributions to adding IRA distributions?
00:20:29.940 | And once we meet our spending goals, should we keep going with that and also do Roth conversions?
00:20:37.220 | Constraints on this, well, do we have available funds in our taxable account, tax deferred
00:20:41.100 | account, tax exempt account?
00:20:43.740 | Then another constraint is, where are we starting on the tax map?
00:20:46.740 | We don't get to start at zero with ordinary income.
00:20:48.940 | We may have other sources.
00:20:50.840 | So we may have required minimum distributions.
00:20:53.220 | We may have Social Security benefits, interest and dividends from our taxable accounts that
00:20:57.740 | we can't avoid, any other taxable income sources beyond this, pensions, even employment, anything
00:21:03.700 | that's generating taxable income.
00:21:05.560 | We have to use that as our starting point.
00:21:07.860 | And then if we're retired, what is our spending goal?
00:21:10.540 | How much are we actually trying to spend on a pre-tax basis?
00:21:14.300 | That's also going to put constraints on our behavior, because we have to make sure we
00:21:17.260 | at least get the funds we're trying to achieve to meet our spending needs.
00:21:21.820 | Okay.
00:21:22.980 | So then we take the tax map, and this is the way I've been thinking about this more recently.
00:21:27.660 | It's this idea of building a tax map.
00:21:30.940 | There's a software out there called Covisum that helped me learn this specific methodology.
00:21:36.900 | But what you do is, well, the question is, what we need to solve is, what tax rate should
00:21:42.700 | we try to manage?
00:21:43.700 | What effective tax rate should we manage?
00:21:45.980 | And it boils down to basic options are, and we'll just use, even though there is no 15%
00:21:51.860 | bracket right now, in 2026 it returns, should we use the 15% bracket, should we use the
00:21:58.180 | 25%, should we use 28%?
00:22:01.340 | I think most of the answers will fall somewhere along there, and it depends really how much
00:22:04.620 | money do you have.
00:22:06.100 | 15% could be the answer for someone who has a runway to do some tax planning and maybe
00:22:11.560 | has one to two million dollars.
00:22:14.180 | As we're getting up, I've looked at cases where there's five and a half million dollars
00:22:17.620 | to work with and finding that maybe going into that 28% bracket can make sense in those
00:22:22.180 | scenarios.
00:22:23.180 | But here, we're just simply, we have to figure out what bracket to manage.
00:22:26.920 | Right now I'm just showing you how to make your decisions given that you have a bracket
00:22:30.220 | to manage.
00:22:31.220 | So if you're trying to manage the 15% bracket, how much income should you generate?
00:22:36.700 | The idea is, you want to look for, there's a roller coaster here.
00:22:40.500 | The tax rate can go above 15%, but it can come back down below 15% again.
00:22:45.700 | Sometimes it may make sense to generate some income at a higher rate because then you have
00:22:49.740 | a big runway of income at a lower rate again, and that's what we're trying to figure out.
00:22:53.900 | Those black dots are marking points where we go above the 15% bracket.
00:23:00.300 | And so we want to check those.
00:23:01.540 | Well, if we go up to the, starting from zero, zero's identified too, but the first black
00:23:07.100 | dot there on the 15% bracket happens with the preferential income stacking, where the
00:23:11.540 | marginal tax rate would go up to 27%.
00:23:14.580 | We can generate income up to that point at an effective marginal rate for that whole
00:23:18.340 | chunk of income of 7.9%.
00:23:20.860 | So that's desirable.
00:23:21.860 | We want to do that.
00:23:22.860 | Then we're going to check that next group where we're going to go back down below 15%
00:23:27.240 | because of that $200 gap that I mentioned earlier.
00:23:30.620 | There is another place where we're paying at 12% for $200.
00:23:33.300 | Well, let's check it.
00:23:35.180 | No, that's going to be too high of an effective marginal rate.
00:23:38.620 | So if I was managing the 15% bracket here, I would go up to where that preferential income
00:23:43.140 | stacking became an issue.
00:23:45.620 | What if I wanted to manage the 25% bracket?
00:23:47.980 | Well, in this case, I go up to that income stacking, and that's the same.
00:23:52.140 | I can do that successfully.
00:23:54.500 | Then if I go into that preferential income stacking issue, once I get past that, I'm
00:24:00.140 | back down to the 22% bracket for a while.
00:24:03.060 | But then I'm going to hit that first IRMA surcharge.
00:24:05.140 | Well, if I check what is the effective marginal rate on that chunk of income, it's 23.3% under
00:24:11.940 | our 25% threshold.
00:24:13.740 | So that's OK.
00:24:14.740 | We'll go ahead and do that.
00:24:15.740 | And here, the answer is basically generate income up to the IRMA threshold.
00:24:19.740 | And what I'm assuming about the IRMA threshold is I'm just using this year's numbers to make
00:24:23.860 | the tax map because it's going to only be relevant-- two years later, I'll pay the tax.
00:24:28.180 | But that's-- what do we do with that?
00:24:29.620 | I'm just going to assume you pay the tax this year for the purpose of making the tax maps.
00:24:33.500 | We'd stop at the first IRMA threshold because any efforts to go beyond that are always going
00:24:37.900 | to generate average tax rates higher than our target.
00:24:41.140 | However, if we were wealthier, probably, so that we actually decide we want to manage
00:24:45.700 | the 28% effective marginal rate, well, we can actually do that up to the second IRMA
00:24:53.260 | threshold.
00:24:55.380 | And so each-- in this case, the first chunk of income staying under 28% gets us to the
00:25:00.660 | first IRMA threshold.
00:25:01.660 | We could do that at 14.4% tax, which is fine.
00:25:05.460 | Then we have another gap to the second threshold.
00:25:07.220 | We can do that under 28%, so that's fine.
00:25:11.180 | I think I'm at time, right?
00:25:13.380 | So to conclude, we have a progressive tax code.
00:25:17.040 | But if we use tax diversification during the accumulation phase and then use these kinds
00:25:21.460 | of techniques to manage with Roth conversions and tax rate management, we can build retirement
00:25:26.100 | income plans.
00:25:27.100 | Thank you.
00:25:28.100 | [APPLAUSE]
00:25:28.100 | Thank you.
00:25:29.100 | [APPLAUSE]
00:25:29.100 | Thank you.
00:25:30.100 | [APPLAUSE]
00:25:30.100 | Thank you.
00:25:31.100 | [APPLAUSE]
00:25:31.100 | Thank you.
00:25:32.100 | [APPLAUSE]
00:25:32.100 | Thank you.
00:25:33.100 | [APPLAUSE]
00:25:33.100 | you
00:25:35.160 | [BLANK_AUDIO]