decumulation: brokerage tax rate = 15%/(1-basis)?

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Raspberry-503
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decumulation: brokerage tax rate = 15%/(1-basis)?

Post by Raspberry-503 »

Trying to wrap my head around taxes once you stop working as I keep thinkg "22% bracket" but then my only experience has been income from wages, not from investments and unless I'm thinking about it wrong, taxes would be much lower in retirement for the same standard of living:

If I need $100K to live on for illustration purposes:

- I can withdraw say $25,000 my IRA as income but pay no taxes since it's under the standard deduction?

- then I withdraw $81,000 from my brokerage, if my basis is 50% then I'm taxed only on teh 50% above basis, equivalent to (100%-50%)x15% or 7.5%? 7.5% of 81,000 is $6075, so I withdrew 25K+81K = $106K pid $6075 in taxes, so roughty $100K spendable income.

That would make the effective tax rate 5.7%?

the basis on my brokerage is actually much higher (more like 90% today), so I'm thinking be retirement in 8-10 years it'll still be higher than 50%. you can probably modulate taxes even more by choosing lots (not sure if you'd want to sell highest appreciation first or last?)
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Re: decumulation: brokerage tax rate = 15%/(1-basis)?

Post by Raspberry-503 »

income in this case is $25K from IRA + 50% of $86K from brokerage (assuming 50% basis) or $68K.
So I could draw another $83K from the trad IRA for a total income of $151K which is the top of the 12% bracket (including the standard deduction) and roll that $83K for another $10K in taxes?
I've read that it's better to pay taxes from conversions out of cash/brokerage rather than from the IRA itself (I'm still trying to understand why, at least past 59 1/2 where there is no penalty) so we would need to draw more from the brokerage to pay those taxes, reducing the $83K from the IRA to stay in the 12% tax bracket.

I'm starting to understand why there are fancy spreadsheets and paid-for calculators to figure out Roth conversions.
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Re: decumulation: brokerage tax rate = 15%/(1-basis)?

Post by retired@50 »

Raspberry-503 wrote: Fri Jan 27, 2023 10:42 am ... you can probably modulate taxes even more by choosing lots...
Precisely. Use Spec ID for your cost basis method, then you can sculpt your income, which may help you avoid any income tax pitfalls.

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petulant
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Re: decumulation: brokerage tax rate = 15%/(1-basis)?

Post by petulant »

Raspberry-503 wrote: Fri Jan 27, 2023 10:42 am Trying to wrap my head around taxes once you stop working as I keep thinkg "22% bracket" but then my only experience has been income from wages, not from investments and unless I'm thinking about it wrong, taxes would be much lower in retirement for the same standard of living:

If I need $100K to live on for illustration purposes:

- I can withdraw say $25,000 my IRA as income but pay no taxes since it's under the standard deduction?
Correct, if you're married filing jointly. The SD for 2023 is actually $27700. You also get an additional standard deduction of $1500 per person who is 65+.
Raspberry-503 wrote: Fri Jan 27, 2023 10:42 am - then I withdraw $81,000 from my brokerage, if my basis is 50% then I'm taxed only on teh 50% above basis, equivalent to (100%-50%)x15% or 7.5%? 7.5% of 81,000 is $6075, so I withdrew 25K+81K = $106K pid $6075 in taxes, so roughty $100K spendable income.
Remember that the first capital gains tax rate is 0%, not 15%. The size of that bracket in 2023 is $89250. Otherwise, the mechanics of what you describe are correct. It's just that in reality, you won't pay any taxes because the capital gains rate at that income is 0%.
Raspberry-503 wrote: Fri Jan 27, 2023 10:42 amthe basis on my brokerage is actually much higher (more like 90% today), so I'm thinking be retirement in 8-10 years it'll still be higher than 50%. you can probably modulate taxes even more by choosing lots (not sure if you'd want to sell highest appreciation first or last?)
You need to decide on a larger strategic goal and let that dictate your strategy. We don't know anything about your age or legacy goals. So, here are some things to think about:

1. Generally, realizing capital gains in the 0% bracket is advantageous, but that reduces the room you have to realize income from the traditional IRA at 10% or 12%, since they substantially (but not perfectly) overlap. So you could prioritize tax lots with the lowest basis (hence more gains) when in the 0% bracket, and tax lots with the highest basis (hence lower gains) in higher capital gains brackets.

2. If you are retiring in your early 60s and delaying social security, it might be to your advantage to pay taxes and spend IRAs down now (or even perform "Roth conversions") rather than using your capital gains assets even at a 0% tax rate. This would reduce future RMDs, give you more control over realizing income without taxation through the Roth IRA, and it would preserve capital gains to pair better with social security, which has complex taxation rules. Even within this thinking, though, it could be beneficial to mix in some capital gains realized in the 0% bracket to keep some tax lots around with low gains.

3. If you have heirs, then your brokerage assets will have a step-up in basis when you "graduate," but your IRA balance will still be taxable even when they withdraw it. Hence, it might be advantageous to avoid realizing capital gains and use as much space in the 10% or 12% bracket as possible to pay the taxes on your IRA.

4. If you plan to have charitable beneficiaries, then selling your capital gains assets to make budget gets smarter since the IRA balances can be passed to the charity with no tax ever paid by you. RMDs can also be avoided through QCDs after age 70 1/2. This point goes in the opposite direction of the logic in points 2-3.

Hence, you really want a strategic vision first.
petulant
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Re: decumulation: brokerage tax rate = 15%/(1-basis)?

Post by petulant »

Raspberry-503 wrote: Fri Jan 27, 2023 10:53 am income in this case is $25K from IRA + 50% of $86K from brokerage (assuming 50% basis) or $68K.
So I could draw another $83K from the trad IRA for a total income of $151K which is the top of the 12% bracket (including the standard deduction) and roll that $83K for another $10K in taxes?
Yes and no. Long-term capital gains always stack on top of ordinary income. In other words, your tax on ordinary income will generally be calculated without respect to the capital gains, then your capital gains tax will be calculated starting from your ordinary income. So here, you will have $108K in ordinary income plus $43K of capital gains. You will deduct the SD (say $25K for this example) and can think of it as $83K in taxable ordinary income plus $43K in capital gains. The ordinary income will be used to fill the 10% and 12% brackets more or less. Then, the capital gains tax will be calculated on the $43K in capital gains but starting from the position of $83K; the 15% capital gains bracket will more or less apply instead of the 0% capital gains bracket. In this example, if the investor had already committed to realizing $43K in capital gains and $25K in traditional IRA withdrawals, the investor can only realize up to another approximately $40K in ordinary income in the 10/12% brackets while preserving the 0% capital gains tax treatment. If additional ordinary income is realized above $40K (or a total of $65K) then that would incur tax in the 12% bracket but also "push up" capital gains from the 0% to 15% bracket, meaning the economic marginal rate would be 27%. This is not an ideal Roth conversion for many households.
Raspberry-503 wrote: Fri Jan 27, 2023 10:53 amI've read that it's better to pay taxes from conversions out of cash/brokerage rather than from the IRA itself (I'm still trying to understand why, at least past 59 1/2 where there is no penalty) so we would need to draw more from the brokerage to pay those taxes, reducing the $83K from the IRA to stay in the 12% tax bracket.
A Roth IRA is very often superior to taxable brokerage money. With a taxable brokerage account, you use aftertax dollars to buy an asset, lock in a basis, but then pay ongoing taxes on dividends plus taxes on the capital gains. In a Roth IRA, you can put in the same aftertax dollars but never incur additional taxes on dividends or capital gains. Hence, between a Roth IRA and a taxable brokerage account, most investors after age 59 1/2 would prefer to have more money in the Roth IRA. If you perform a Roth conversion and pay the taxes out of the IRA, then you are effectively reducing the amount that could have gone in to the Roth IRA while preserving a taxable brokerage asset, i.e. you are only converting the IRA. On the other hand, if you convert some amount and pay the taxes from the taxable brokerage account, you are getting a bigger Roth IRA and reducing both the traditional IRA and the brokerage account, i.e. you are converting both the IRA and the brokerage account. Depending on your age and total lifetime tax appetite, this may or may not be advantageous. As I stated previously, your overall strategic vision matters. In some cases, if the traditional IRA is still rather large and you have natural person heirs who will benefit from the step-up in basis, it can be superior to perform Roth IRA conversions paying all taxes out of the traditional IRA. If you are lower on the traditional IRA balance side but have plenty of capital gain assets--and your expected legacy is small--it can be more effective to pay for the taxes out of the capital gains assets to get the most efficient setup in the Roth IRA as possible.
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Re: decumulation: brokerage tax rate = 15%/(1-basis)?

Post by Raspberry-503 »

I obviously still have a lot to learn about the decumulation phase. Any suggestions on how to start learning/forming a strategy? (I'll start with the wiki here of course).
Ideally, some SW that either helps me run the scenarios or even run/optimize them would be good. In fact what go me started down that road is that I was looking at the "Flexible Retirement Planner" tool, and realized that I don't understand enough to use its RMD function (it doesn;t baby you thorugh it, you need to understand what you're plugging in)
petulant
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Re: decumulation: brokerage tax rate = 15%/(1-basis)?

Post by petulant »

Raspberry-503 wrote: Fri Jan 27, 2023 1:35 pm I obviously still have a lot to learn about the decumulation phase. Any suggestions on how to start learning/forming a strategy? (I'll start with the wiki here of course).
Ideally, some SW that either helps me run the scenarios or even run/optimize them would be good. In fact what go me started down that road is that I was looking at the "Flexible Retirement Planner" tool, and realized that I don't understand enough to use its RMD function (it doesn;t baby you thorugh it, you need to understand what you're plugging in)
The Wiki is a great starting resource for withdrawal strategies. A lot of people run simple simulations and backtests on portfoliovisualizer.com. Tools that comprehensively consider social security timing, asset allocation, RMDs, and taxes are rare. You might have better luck with that question if you search for or start a thread on planning software tools.
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