Navigating Taxes in Retirement

Comments on “Four Tax Strategies for Retirees,” by Wade D. Pfau, Ph.D., CFA, RICP, in the July 2023 AAII Journal:

I’m thrilled this example is close to my situation. The main message of using a Roth IRA to pay tax upfront for later savings is important. As the article points out, there is a lot of opportunity for tax rates to change over time and create a better position for Roth conversions. That is what I have been pursuing, acknowledging the personal psychological benefit of getting the tax bite out of the way.
—Hugh P. from Washington

One “tax” that early retirees who rely on the Affordable Care Act (ACA) for health insurance (before they reach age 65) also need to consider is the reduction in the ACA subsidy as modified adjusted gross income (MAGI) rises (e.g., from Roth conversions). There is also the potential of the return of the subsidy cliff (complete loss of subsidy) if changes first implemented with the American Rescue Plan and then extended with the Inflation Reduction Act are not extended past 2025 or made permanent.
—William W. from California

Managing the ACA subsidy is key for the period between retirement and Medicare. It’s a pain to do and the rules are complex and changing, but it’s worth $20,000+ a year for a couple. After Medicare, performing a Roth conversion before required minimum distributions (RMDs) hit begins to make sense for the low-income period between ages 65 and 73.
—Anthony A. from California

I decided to take Social Security at age 62 and give up the benefits of waiting until later. My reasoning was as follows: 1) I had retired from all employment and the amount I received at age 62 was more than sufficient to cover all basic living expenses; 2) In a tax-advantaged way, I could move assets from my seven-figure traditional IRA to my Roth IRA to reduce the impact of RMDs at age 73; 3) I am a dividend-growth investor and set a goal to have income from my IRA investments exceed the RMD so I would not be forced to sell assets starting next year at age 73 to cover the RMD; 4) Our taxable brokerage accounts are relatively small compared to our IRAs and Roths, therefore, it is very easy to manage taxes from smaller traditional IRA withdrawals; and 5) I trade covered call options and cash-covered puts, which provide additional income in all of the eight accounts my wife and I own.
—Wayne W. from Wisconsin

The current tax rates will sunset after December 21, 2025, and will revert back to the 2017 rates unless Congress extends them. We have been retired since 2019 and each year have been taking IRA taxable distributions in cash and converting unneeded money to Roth IRAs to stay in our current tax bracket. We both have pensions, and I will start my Social Security payments at age 70. We keep our total income below the Medicare Income Related Monthly Adjustment Amount (IRMAA) threshold to keep our health insurance premiums as low as possible. Even though our RMDs won’t start for five or six years, I have been projecting our annual taxable income with RMDs after IRS Publication 590-B is updated and discuss it with my wife.
—P.B. from Florida

Did you try not spending all the taxable account and saving it as a stepped-up legacy generating no taxes? This is what I am doing here: https://seekingalpha.com/article/4606236-growth-no-dividends-one-year-later. I created my own no-dividend portfolio just for that purpose so it won’t add taxes.
—Dave G. from Texas

For the commenter who asked if anyone has a spreadsheet to help calculate/visualize the figures: I use the Microsoft Excel–based Pralana Retirement calculator to perform and model my own calculations, https://pralanaretirementcalculator.com. I am a fan of income smoothing on lifetime income taxes and maximizing lifetime aftertax income based on one’s available assets and remaining life expectancy/retirement planning horizon. I am aware of three other affordable retirement calculators that can estimate lifetime taxes and perform income-smoothing calculations:

• https://i-orp.com (free),
• https://maxifiplanner.com and
• www.newretirement.com.

—J.M. from New Jersey

The strategy of delaying Social Security benefits and making use of Roth IRA conversions early in retirement depends on the assumed low reinvestment rate of 4.29%. If it is assumed that the reinvestment is higher, at 8.0%, the optimal strategy would be quite different. I think the author should have made it clearer that results are very sensitive to the reinvestment rate assumed.
—Brian H. from Texas