Self-Inflicted
I���M NOT IN THE HABIT of celebrating half-birthdays, but my next one has me thinking. In a few days, I'll turn age 59��.
That, of course, is the age at which you can tap your retirement accounts without paying the 10% early withdrawal penalty. Though I don���t currently need to pull spending money from my retirement accounts, I like the feeling that I can now do so penalty-free.
Even without that 10% penalty, however, there���s still the small issue of income taxes. The good news: More than a fifth of my investment portfolio is in tax-free Roth accounts, with another tenth in a regular taxable account. The bad news: The other two-thirds are in a traditional IRA. Every dollar coming out of that traditional IRA will be dunned at ordinary income-tax rates.
That prompted me to do a quick, back-of-the-envelope calculation. If I put off all traditional IRA withdrawals until they���re required at age 72, and I assume modest investment gains, and I add in Social Security benefits and other income, I���ll likely find myself near the top of the 24% federal income-tax bracket when I'm in my 70s. A reliable estimate? Given all the variables involved, I consider it more of a rough guess.
Indeed, based on current tax law, there���s a possibility I could end up paying a 32% marginal rate���and there���s a decent chance tax laws will be different a dozen years from now, especially with parts of 2017���s tax law scheduled to sunset at year-end 2025. On top of that, I���ll most likely have to pay higher premiums for Medicare Part B and Part D, thanks to so-called IRMAA surcharges. For me, those surcharges could amount to an extra tax equal to 2% or 3% of income.
Meanwhile, this year, it looks like I���ll land in the lower part of the 24% marginal federal tax bracket. The upshot: I figure there���s some incentive to shrink my traditional IRA over the next few years, so there���s less risk I���ll end up paying higher taxes���and heftier Medicare premiums���later on. To be sure, by opting to draw down my traditional IRA before I'm compelled to, I���ll be inflicting large tax bills on myself. That's hardly a pleasant prospect.
Still, it strikes me as the rational thing to do. To that end, now that I���m turning age 59��, I could start pulling money penalty-free from my traditional IRA, and continue to do so throughout my 60s.��But given that I don���t need the spending money right now, it makes more sense to convert chunks of my traditional IRA to a Roth each year, where the money will then grow tax-free. Keep in mind that you don't have to be age��59�� to do a Roth conversion. Indeed, I've done a few over the years, including a big one in 2010, when I converted my��nondeductible IRA.
With the Roth conversions I'm currently planning, my goal is to make the most of the 24% income-tax bracket, but try mightily to avoid generating so much extra income that some of it gets dunned at 32%.��The incentive to shrink my traditional IRA is especially great this year and in the three years that follow.
Why? There are two reasons. First, in 2026, I turn age 63, meaning I���ll be two years from claiming Medicare. At that point, any extra income I generate has the potential to boost my Medicare premiums, because the IRMAA surcharges are based on your tax return from two years earlier. Second, in 2026, parts of today���s tax law sunset and, at that juncture, it may take far less income to land in a high tax bracket.
My plan: I���ll convert $60,000 now. Later in the year, when I have a better handle on my 2022 income and how close I am to the top of the 24% tax bracket, I might convert another $10,000 or so. Why not just wait until late 2022 and do a big conversion then? I don���t know whether the stock market will be depressed later in the year���but I know it���s depressed right now. I like the idea that the $60,000 I convert might bounce back with the broad stock market, and that those gains would be tax-free.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier��articles.The post Self-Inflicted appeared first on HumbleDollar.
