I have a well documented plan for post retirement risk management, which includes varied accounts, pre-tax, taxable brokerage, and Roth. My plan is to annuitze the pre-tax accounts through RMD after whittling down their present size through Roth conversion to something that won’t force me into higher tax brackets too quickly. It’s a perverse race between taxes and death. My Roth is primarily disaster money, in case of emergency break glass. The Roth is the most valuable money I own since I own it tax free, while the other two are still taxable, as ordinary income in the case of the pre-tax, and as capital gains in the case of the brokerage.
My pre-tax RMD has included a tax discount because a certain percentage of it was funded with post tax money and the government only taxes you once on pre-tax money. As I was working through my taxes it occurred to me there may be a different format for disaster spending, by spending down the pre-tax money first.
This is a picture of a $600K RMD amortized on the government’s schedule over 45 years @ 3% return. The green is the yearly disbursement and blue the remaining portfolio. It occurred to me after the 7.5% “standard write-off deduction” is met, in the case of a medical emergency you could basically extract extra money from the account tax free, never paying taxes once you meet the threshold. This means a 600K @ 3% pretax (mostly bonds) could provide about 8 years of of catastrophic care @ 85K/yr essentially tax free or at a very low rate. That extra 8 years of growth would be tacked onto the Roth and Brokerage. A 1M Roth would be worth 1.5M if it were risked in a portfolio returning 6% for 8 years with no withdrawal.
Let’s say you make 40K/yr on SS of which 85% or 34K is taxable lets say you generate a $50K bill fighting your cancer diagnosis. The 7.5% threshold is $2,550 so you should be able to pull $47K out of your pre-tax account, tax free to pay your medical bills, and leave the Roth to grow and pay your living expense later if you survive. Your married filing jointly tax bill would be less than $1K/yr on $90K of spendable money You can pull 50K/yr from a 3% 600K portfolio for 15 years before the stream runs dry. In the meantime the Roth grows to 2.3M. How do you spell relief? I spell it “well thought plan”.
A nice strategy to have up your sleeve if the time comes.
2 Replies to “Skinning Cats and Fleshing Out Disaster Funding.”
I had a pretty high basis because I had an IRA that was funded with post-tax money that, because my income was too high, was not tax deductible.
This past year I did a mega backdoor Roth to get that money into a ROTH IRA (I had some other IRAs that I had to rollover into my employer 401k so I could avoid the pro rata tax hit.
So I guess by doing that I eliminated this strategy that you proposed. But I still think I would have done it the same way to get it into a ROTH where it can hopefully grow tax free from now on
Having different piles of money with different tax risks is step 1. Step 2 is choosing the disbursement option that makes the most sense based on tax liability. If you had a high RMD you would pay more taxes, and a medical disaster would “cut” your tax bill but that’s a hell of a way to get a tax cut. I think a Roth is the first line of defense for portfolio longevity but not necessarily the first line of offense in a disaster. Sometimes you sacrifice a pawn in order to take a Bishop or Knight. I’m not necessarily recommending it but substituting a TIRA spend down vs a Roth spend down in the face of a potential improved tax write off is worth keeping on the table as an option especially if the Roth has higher growth.
In your case as a single filer as opposed to married it might be an even greater advantage since the tax law is progressive. Once you hit the 7.5% threshold your money goes to pay for your diagnosis instead of taxes, so pulling more money out of the TIRA doesn’t progress your tax bill. This might be very important consideration for say a widow who gets a bad but only slowly fatal chronic diagnosis like NDD and is faced with catastrophic end of life choices.