I’ve written a lot on efficient Roth conversion and getting to the magic RMD age presently age 70 but hopefully soon to be 72 with the SECURE act. Bogglehead technique is to make 25x or 33x your need, leave it in a fairly high risked investment vehicle typically a IRA and dole out 3% or 4% /yr to provide income. It’s a method that will likely work, but the ride may be harrowing because of sequence risk, market timing etc. The problem with “MAX OUT YOUR PRETAX” is those accounts are tax deferred not tax free and the tax code is progressive. You eventually have to pay and how much you pay is income dependent. The Bogglehead bet is growth eventually outperform (if growth is 5% and you’re sucking 3% to live on you still have 2% in the kitty). On the average it should work.
Retirement in my universe is retirement as in age 65 collect SS, have Medicare as an insurance basis and living off the proceeds of my nest egg. Your choice of blog income or books or courses and marketing your clever expertise doesn’t interest me. My focus therefore is how to live the best passive investment life I can with good control of risk. My retirement income therefore comes from cash flow provided by several passive streams from several accounts that have different tax treatments. Rather than conflate FIRE with FI retired age 65, I’m going to discuss FI age 65.
One account is cash. I keep my cash in a high yield no frills savings account. My cash is what let’s me Roth convert efficiently. I have plenty of “money” to live on while generating my income exclusively from Roth conversion. My cash pile was generated by selling post tax brokerage stock near the market high in 2016 and mixing that with tax loss harvest obtained over the decades . My cash pile therefore was generated pretty much tax free. The entire efficiency of the Roth conversion exercise relies on having a cash pile.
A second account is my post tax brokerage. At age 50 or so I realized “MAXING OUT MY PRETAX” meant I was ceding control of my tax burden to the government. At age 70 your burden becomes fixed and it’s payment is on the government’s terms. I never qualified for the TIRA middle class funding gimmicks anyway since I made way to much money. IRA money comes out as ordinary income and is subject to the progressivity of income tax. RMD forces the issue. You will take a predefined amount of income every year and you will pay the appropriate tax on that. I started therefore aggressive saving in post tax brokerage instead which has a different tax treatment upon disbursement. It’s taxed as LTCG not ordinary income and there is no RMD forcing sale. Mixed with some tax loss harvest the money comes out tax free not unlike a Roth.
A third account is the Roth. I fund the Roth through Roth conversion of TIRA money. The Roth has specific tax treatment in that the money comes out tax free including cap gains upon disbursement. The tricky part is determining how much Roth you are going to fund and over what period. All in one conversion is most expensive from a tax perspective with smaller conversions much more efficient, so you have variables of conversion amount that sets your cost of conversion as well as number of conversions. If you have a big honkin MAX OUT YOUR PRETAX kind of TIRA you’re going to have a big honkin tax bill to pay. By fooling with payments a most efficient conversion can be obtained where the effect of progressivity of the tax code is minimized. The downside of a big number of conversions is you need cash to live on while doing the conversion and you may not like having a million bucks sitting in cash even if there is good rational to be in cash. Being in cash also limits market fears since once sold you don’t have to worry about selling into bad market conditions. Your portfolio is exposed to growth but not SORR since during that period the portfolio is closed and cash is providing income. It turns out there are bumps in conversion as there are various things in the tax code where you move from being middle class to being wealthy from a tax treatment perspective. Dodging the bumps allows you to convert more money more cheaply. An example is the medicare 3.8% surtax. If you convert to the top of the 24% bracket (341K/yr) you pay it if you stay under a 250K/yr conversion you don’t
The last of course is the TIRA itself. It turns out the government really does soak the rich. The government does not soak the middle class despite all the talking points. It’s better for the government to engineer around a standard kind of retirement where people can more or less take care of themselves with some SS and some TIRA income. The top of the 12% bracket (104K including standard deduction MFJ) ordinary income is the breaking point. Below that income and cap gains are treated with pretty low taxes plus 0% cap gains, Above 104K you go to 22% marginal and 15% cap gain.
The question then becomes what is a “middle class” retirement since that retirement is fairly advantaged. I did some research and found a TIRA of 500K – 600K is a typical retirement amount over SS. By analyzing various RMD schedules some insight developed.
This is 500K TIRA @ 6% return from the Schwab calculator. Notice how the curve grows and notice the RMD amount grows as well. There is the concept of top of the bracket where your income will kick you into the next bracket sooner. If growth is slower your position in the bracket changes only slowly since ordinary income is the combination of SS + RMD. SS is COLA adjusted and tends to grow and as you can see 6% RMD also tends to grow and the combined growth will kick you out of the bracket sooner.
This is a 500K RMD @ 3% growth. Notice the reduction in volatility and the steady slow growth. A 3% TIRA allows you to get TIRA money in a quite predictable way with low volatility and very predictable taxes and keeps you in the bracket for a long time. It also protects against SORR and even at age 99 there is money available in case you need a few thousand extra. The 3% TIRA therefore acts like a bond and provides bond like stability and bond like predictable tax consequence to your retirement income.
You have the ability therefore to clean out the TIRA into a Roth all except 500K which you leave as portfolio non correlated balance, non correlated since bonds are the likely asset choice for this asset.
Here a retirement income schedule I concocted using a SS of 44,800 inflation adjusted a 2%, plus the actual RMD of 500K @ 3% growth. Expense is the yearly expense I want inflation adjusted. WR is the amount I will need to withdraw from brokerage to make up the difference between “expense” and SS + RMD with litle consequence on the tax bill and you can see a nice gently increasing tax as well. The WR comes from my brokerage account. In addition the Roth stands alone. It’s value starts with whatever I cleaned out of the TIRA before RMD and is allowed to grow pretty much unmolested. I my case my goal is about 1M in Roth at the end of conversion in 10 years it will have about 1.8M and is available to self insure our lives in case of disaster. The spend down will go: spend down the TIRA as outlined, spend down the brokerage as outlined, don’t spend the Roth unless needed.
The risks are dispersed by tax treatment as well. The TIRA has low risk. The brokerage has what ever risk/asset mix you like and the Roth also can have its own risk and asset mix. You can work backward to understand the cost. Initial cost to me was 600K of stock converted to cash, about 200K of tax paid on the 1M conversion and the taxes displayed ongoing. If you had a 2M brokerage left after generating the cash pile and a 1.5M TIRA at 72 you would have 1M in Roth 500K in TIRA, 2M brokerage and a WR around 2.5%. Presumably at that low of a WR brokerage will continue to grow as well. Each aspect needs strategic consideration. If I just “maxed out my preretirement” my tax bill would be huge and what is left smaller. Point being what you do in accumulation matters and having enough time implement the pan matters. Spend down is very different than accumulation. Quitting too early matters, quitting too late matters. Limiting the scope of what is “retirement” and what is financial independence matters A far cry from 4×25