[Jasmine]

I was chatting with a friend who’s retiring later this year at age 60. He’s a high earner who’s diligently contributed to a traditional 401k over decades. One of his concerns is having a massive forced tax hit when reaching RMD age.

He’s going to see a fee-only professional to help work through things, but wants to do some reading/research in advance so he understands key concepts and can have a more informed conversation.

What should he be exploring?

My initial thought was some combination of Roth conversions and tax gain harvesting. For example (hypothetical, not his real numbers),
— Imagine the couple wants $80K/year for living expenses in retirement

— Take $123k from the 401k ($80K withdrawn for expenses, $43K converted to Roth IRA)

— This generates $123K of ordinary income, or $94K after standard deduction.

— Their marginal tax rate (Federal) would only be 12%, effective tax rate would be lower

— $43K converted amount is now growing tax-free in a Roth IRA, will have tax-free withdrawals and be immune to RMDs.

— So basically force extra tax events in pre-RMD years and pay at a very low tax rate, in order to avoid (or at least mitigate) massive tax bills at high tax rates when 73+.

Is this thinking vaguely along the right track?

(For the purposes of this discussion, assume married filing jointly, both retired and 59.5+, kids grown up/moved out, bulk of retirement assets in traditional 401k, possibly a much smaller amount in brokerage and IRAs)

[Brian]

Do you know if he has money in Roth accounts already?
I would think someone who is under 60 and has diligently invested in their 401k might have also made Roth IRA contributions.

And are you sure that none of the 401k money is in the Roth 401k?
And his RMD age is 75.

Not trying to be flip, but given the circumstances, won’t it be not so difficult to avoid the RMD hammer?

[Rick]

A few aggressive ideas.
Drive down expenses. Lower expenses in your example drives down taxable income dollar for dollar.

Also having any debt like say a car loan become unnecessarily expensive when you honestly begin to include the income tax paid to generate the money to pay the loan becomes an increase to the actual loan rate, meaning even a 0% car loan usually does not make sense when you pay 15% income tax to generate the money to pay it.

Delay SS to max age to again keep control on taxable income.
Consider travel point efforts as they are fairly easy to accumulate via a handful of new card bonuses and their accumulation and spending is tax free.

It’s not hard to get $10k value annually and that could be a decent part of their $80k expense instantly reduced. Possibly to be replaced with larger Roth conversions.

Try to avoid “unnecessary” taxable income. Like large cash or CDs throwing off interest.

Making any brokerage account trades that cause any type of cap gain. Buying/holding big dividend payers in their brokerage account.

Each of these things can be good ideas but when done very purposefully. Many people just don’t do them that way so they have “unnecessary” taxable income.

Sell primary residence to downsize. This pairs well with #1 tip above on cut expenses.

But it also likely frees a ton of equity money, likely at no tax upon sale, and can be used via fungible money theory for living expenses for years….allowing much much bigger Roth conversions.

If the above idea of downsizing is just a few short years away, math up the idea of us in a heloc to start using equity now for tax free income.

Don’t try to be a market timer on Roth conversion but if the timing of Roth conversions is planned for let’s say June 30 or December 1 for whatever reason…and the market has a sizable drop before that date, they should strongly consider moving up their Roth conversion date and do it while the market is down.

The result is higher net Roth conversions for the same amount of tax.

[Ron]

Yes, it’s the right approach. I’ve been doing conversions in early retirement since 2018.

I would first try to understand, though, what the RMD will be at OPs projected RMD age traditional balance (1st assuming no conversions).

I’ve only explored RMDs on about the 1/2 million level and it’s not actually that much.

Of course if the friend has other income like a pension it might be a different situation, but I’m just suggesting to actually measure it out.

I have a feeling that at some point not too far from now it will make sense for me not to do Roth conversions.

But this is something you can look at each year and adjust as you go along.

[Christopher]

I think is generally the right approach. Loss harvesting (if available) can also be used to boost the conversion amount in some years, as can other deductions that might apply to their situation.

If they’re charitably inclined, they can also donate from a traditional IRA to offset their RMD (this is a Qualified Charitable Donation or QCD).

[Bill]

RMDs really aren’t that bad. They start around 4%. That’s a ballpark of what you should be spending, not some absurd number.

Yes, you can do Roth conversions to take advantage of a lower bracket, but the real underlying problem is that some people just don’t spend/give enough and end up with way to much money.

That’s the only real way you end up with runaway rmds.

[Amy]

He has another thing that he needs to worry about. At age 60, he’s going to have to cover health insurance until Medicare at 65.

He can potentially use COBRA to cover 18 months of health insurance, but he’s going to have 4 – 5 years to cover before Medicare, so unless he has retiree coverage, he’ll probably need to use ACA for 2½ – 3½ years.

Beginning in 2026 the 400% of FPL cliff will be back in place, so doing Roth conversions at that level will ensure that they will be paying their entire premium, without getting any subsidies.

So, during the years he’s on ACA, he may want to keep the conversions under 400% of FPL.

For 2025, that would mean he would need to keep his AGI under
$81, 760. (Note: AGI is before you take the standard deduction out.)

[Author]

Posts