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Opportunity cost of RMD tax reduction strategy

Posted on 3/29/25 at 10:20 am
Posted by Artificial Ignorance
Member since Feb 2025
286 posts
Posted on 3/29/25 at 10:20 am
Appreciate the board’s thoughts on the following

Context:
Will retire at 55.
Pension at 65.
SS at 70.
RMD at 75.

Plan is to put cash from Severance, et al. into tax free (Muni’s) acct and draw from it for 1st 4-6 years of retirement. In parallel, will convert tax-deferred accts to Roth at lower tax rates (will do this for 1st 10 yrs) to reduce tax deferred balance significantly by the time of RMD, thus reducing tax at 75.

This makes sense to me to reduce ticking tax bomb when turn 75. About 60% of retirement portfolio is tax deferred.

Pension and SS will cover 100% of expenses at that point so RMD is not needed and it will be taxed at higher bracket rate in those years.

Multiple CFPs have validated. I get it. However, not one has mentioned or calculated the opportunity cost of paying taxes years 1-10, that otherwise would grow over the 20yrs leading up to RMD years.

Challenge my thinking / blind spots, please.
Framing the decision as follows:

PV of opportunity cost - what would those taxes paid in yrs 1-10 have grown to as tax deferred dollars across 20 yrs to RMD?

Vs

The difference in:

PV of taxes applying the tax reduction strategy across RMD years

Vs

PV of taxes without applying the tax reduction strategy across RMD years

Are there any guidelines for what would have to be true for…PV of the opportunity cost > PV of the value created from the tax reduction strategy?

Market returns of X %?
Effective tax rates of Y %?




This post was edited on 3/29/25 at 10:42 am
Posted by horsesandbulls
Destin, FL
Member since Jun 2008
4991 posts
Posted on 3/29/25 at 11:00 am to
Consider Qualified Charitable Donations if you have enough coming in from everything else to live off of. Can donate up to RMD amount and you won’t pay tax on the distribution.

Talk to your advisors about it.
Posted by La Place Mike
West Florida Republic
Member since Jan 2004
30158 posts
Posted on 3/29/25 at 2:54 pm to
quote:

RMD is not needed and it will be taxed at higher bracket rate in those years.


How do you know what tax bracket you will be in by that time?
Posted by PlanoPrivateer
Frisco, TX
Member since Jan 2004
2883 posts
Posted on 3/29/25 at 3:57 pm to
quote:

will convert tax-deferred accts to Roth at lower tax rates (will do this for 1st 10 yrs) to reduce tax deferred balance significantly by the time of RMD, thus reducing tax at 75.


I am not understanding this. If you convert tax deferred accounts to Roth then you won't have to take RMD at least under current law.
Posted by TorchtheFlyingTiger
1st coast
Member since Jan 2008
2606 posts
Posted on 3/29/25 at 4:13 pm to
Thats what OP is saying, converting as much as they can in a low bracket to Roth to avoid a large traditional balance w big RMDs.
Posted by TorchtheFlyingTiger
1st coast
Member since Jan 2008
2606 posts
Posted on 3/29/25 at 5:02 pm to
All else being equal (same tax rate and rate of return) there is no opportunity cost difference between paying tax upfront versus later. Thanks to the commutative property of multiplication the final balance.is equal if you invest the entire balance and tax it at the end or tax it up front and invest the remainder to grow tax free.
I think you have the right idea locking in a low bracket while it's known. Additionally, you may reduce impact of IRMAA, tax on SS benefits etc by realizing taxes early before those are applicable. If married it also reduces vulnerability to 'widow's penalty.'

What I've had difficulty figuring out is whether to prioritize using the 12% bracket to harvest long term gains at zero tax rate in my brokerage versus reducing traditional balance via Roth conversions.
That's why I'm looking for a software and/or CFP to help model strategies.

I'm leaning towards Roth conversions since heirs will get stepped up basis in taxable brokerage anyway whereas the tax has to be paid on traditional either by me, surviving spouse or heirs who are likely to be in higher brackets. Kids likely will be mid career near highest income years and only get 10 yrs fully liquidate traditional inherited IRAs.

I dont have much space remaining in 12% bracket though and Roth conversions in 22% bracket are less compelling (but likely still a good idea but I need to see it modeled.)

Posted by TorchtheFlyingTiger
1st coast
Member since Jan 2008
2606 posts
Posted on 3/29/25 at 5:20 pm to
The tax free muni bond allocation isnt something I've given much thought. But it makes me think if you have plenty SS and pension to meet needs (without even spending from retirement accounts) can you afford to take more risk with your portfolio than a massive bond allocation? If so, you can minimize taxes in taxable brokerage by investing in low yield index funds and harvest gains and basis tax free as long as you remain in 12% bracket (and tax rates on LTCG dont increase). Of course, that would reduce bracket space available for Roth conversions and you only have 10 years to get those done before pension kicks in eating up most of your lower bracket space.

Thats my situation, collecting pension already so little space for low tax bracket conversions each year.
Posted by Artificial Ignorance
Member since Feb 2025
286 posts
Posted on 3/29/25 at 8:45 pm to
quote:

How do you know what tax bracket you will be in by that time?


I will retire. No more income. Therefore, will control the tax we pay by amount, conversion and account from which we withdraw money for our retirement expenses.
Posted by Artificial Ignorance
Member since Feb 2025
286 posts
Posted on 3/29/25 at 8:55 pm to
Thank you for your thorough and thoughtful responses. Very helpful.

I re-calculated and PV math says the opportunity cost of RMD tax reduction is worth half of the value created by lowering RMD and taxes.

CFPs 1, Me 0 (shocker!).

I will play with the return req’d but quick glance suggests would require more risk than I am willing to take.

Your point on taking greater risk (as pension and SS cover expense needs and offer peace of mind) is a good one will consider.
This post was edited on 3/29/25 at 9:14 pm
Posted by CharlesUFarley
Daphne, AL
Member since Jan 2022
713 posts
Posted on 3/29/25 at 8:59 pm to
What is your plan for health insurance? If you will use Obamacare, that muni income, and your Roth conversion, could make you pay more for Obamacare.

Next year the Obamacare cliff returns, which means 1 penny over a certain income could cost you tens of thousands of dollars in premiums.

If you have a Roth 401K and can draw from it at age 55, the Roth income doesn't count towards MAGI, but muny does.
Posted by La Place Mike
West Florida Republic
Member since Jan 2004
30158 posts
Posted on 3/29/25 at 9:05 pm to
quote:

I will retire. No more income. Therefore, will control the tax we pay by amount, conversion and account from which we withdraw money for our retirement expenses.


Okay, but you said you would be in a higher bracket. How do you know that?
Posted by Artificial Ignorance
Member since Feb 2025
286 posts
Posted on 3/29/25 at 9:15 pm to
Blessed to keep same health insurance as when employed w/company covering 80%, full share. Have been at company for many years, one of great benefits.
Posted by Artificial Ignorance
Member since Feb 2025
286 posts
Posted on 3/29/25 at 9:20 pm to
I am speaking to when I am 75, RMD year 1.

As pension and SS will cover retirement expenses in full in RMD years, the RMD will be stacked on top. Therefore. can calculate the brackets that RMD will reach into.

I am using current tax tables.
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