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Making Sell Decisions for Income: Managing The Distribution of your Accumulation
I have been reluctant to rev up a Roth conversion strategy since the ACA subsidy rules are income specific (right now Roth conversion would negatively impact my ACA subsidy).
Once you reach Medicare age, conversions can similarly affect premium costs. Currently, if your MAGI (which includes tax free income like muni interest but not Roth distributions) exceeds $85K for an individual (or $170K for a couple), you're subject to a Medicare surcharge, called IRMAA. This applies to both parts B and D.
I also believe that the best time to consider Roth conversions is after of market pullback which is anyone's guess.
A common strategy here is to make multiple conversions over the course of the year (assuming you're not planning to convert everything in the current year) and then next April recharacterize ("unconvert") the ones where you did the worst. You keep the conversion(s) where your investment went up the most, and undo the others. Just make sure that you convert into separate Roths, because the IRS looks at how the total Roth performed in computing how much you undo, not just how much one particular fund did. To keep the performance figures "pure", keep the Roths separate.
"Generally, only one qualified HSA funding distribution is allowed during the lifetime of an individual."
Agree with this, a one time (at any age) direct roll over (trustee to trustee) from a TIRA to an HSA. I did this the first year I funded my HSA.
In subsequent years individual have to find other funding sources. HSA can be funded with both earned and unearned income so a retiree can use a portion of their unearned income to fund their HSA and lower their taxable income dollar for dollar (as a tax credit). Most other IRAs require earned income as the "funding source", HSA do not.
For individuals/couples who would otherwise struggle to find a funding source to fund an HSA (too much month at the end of the pension check), one becomes available at age 59.5 in the form of your T.IRA.
Take a T. IRA taxable distribution equal to your HSA contribution. The two offset one another with regard to taxes, one is a taxable event and the other is a tax credit. For 2017, this "T.IRA to HSA conversion", would amount to $4400 for an individual HSA plan and $7750 for a Family HSA plan (this includes catch-up provision).
A couple could shift about $46K out of the T.IRA into their HSA between the years of 59.5 - 65. At a tax rate of 20% that would save over $9K in taxes that could be used to help pay healthcare costs. They also have shifted $46K out of the T.IRA that will grow tax free and will not impact RMD calculations.
Thanks for the feedback PRESSmUP . Sounds like you have a plan. I 2nd bee's fondness of HSA's. I think they are the best tax free (on both ends) investment going.
"For individuals/couples who would otherwise struggle to find a funding source to fund an HSA (too much month at the end of the pension check), one becomes available at age 59.5 in the form of your T.IRA."
That's a good point, and perhaps the only situation in which funding an HSA out of a traditional IRA makes sense.
So long as you have available cash, and income (earned or otherwise) that the HSA contribution would offset, it is better to use that cash. That's because you wind up with more sheltered money.
But if you don't have the spare cash available, funding out of the IRA can serve as pseudo-Roth conversion.
The cynical side of me thinks: Paying taxes (Roth IRA) first would reduce AUM for managers like Edelman by the investor's tax rate or between 20-30%. This would equate to a 25-42% loss of profits over a 30 year time frame with a 1% fee schedule comparing a "smaller" Roth IRA to the unconverted "larger" T.IRA...not good for his bottom line.
In the end, the investor may end up with the same results (after taxes), but Edelman would not. He would much prefer to receive 1% from a much larger account balance (tax deferred IRAs) hence the real reason for his answer.
Note: "Congress (has) imposed a special rule. If you take a distribution from the conversion money in your Roth IRA within five years after the conversion, the early distribution penalty will apply even though the distribution isn’t taxable. Example: You convert your traditional IRA, with a value of $20,000, to a Roth IRA, paying tax on the entire amount. Two years later, when you are under age 59½, you withdraw $5,000 from the Roth IRA, and the distribution comes from conversion money because you haven’t made any regular contributions to your Roth IRA. The distribution isn’t taxable because you already paid tax on that amount in the year of the conversion. You owe a $500 early distribution penalty, though, (10% of $5,000) unless you qualify for one of the exceptions (such as disability or medical expenses)." http://fairmark.com/retirement/roth-accounts/roth-distributions/distributions-after-a-roth-ira-conversion/
I've done 3 conversions during the past decade. Aside from the question of whether the early tax hit is off-set by the tax exemption of future growth (Davidmoran's point), there are other advantages for which it's difficult to assign a monetary value (bee's point):
- If you're fortunate enough to convert an asset near its market bottom (easier said than done) you do very well because the eventual sharp rebound in value is exempt from whatever type of tax would have applied to it outside the Roth. This worked quite well for 2 of the 3 conversions I did. (The 3rd is slightly ahead after 2 years).
- As bee says, there are no RMD requirements (that I know of) for Roths.
- If you have Traditional IRAs at multiple custodians, you can simplify your tax preparation (but not lessen your tax bill) by converting all but one account to Roth status. Without even planning to do this, I'm pleased that because of the conversions, my Traditional IRA is solely with one custodian.
I'm not a purist - so have taken distributions from both the Traditional and the Roths in recent years. However, I'd agree with the others that ideally one take distributions from the Traditional first.
Advice: Try to keep conversions separate by year so you can easily keep track of the 5-year restriction. In other words, do one at Custodian A in 2017 and another at Custodian B in 2019. Intermingling different conversions - especially within the 5 year window - can really complicate tax preparation.
In the discussion portion of a @PRESSmUP link I found this Optimal Retirement Planner:
"The Optimal Retirement Planner (ORP) computes your tax-efficient schedule of retirement savings withdrawals for your entire planned retirement. Withdrawals from your Tax-deferred account (401K, IRA, SEP...) are subject to the Federal progressive personal income tax. The order in which you make withdrawals from your Tax-deferred, Roth IRA, and After-tax accounts affects your total retirement disposable income."
>> He would much prefer to receive 1% from a much larger account balance ... hence the real reason for his answer.
@bee, If your cynicism and imputation of bad faith / fee grubbing were the case, it seems to me Edelman probably would not have offered this advice (backed with math in tax tables) to all comers publicly for over a decade, free, online and over the air. Instead he would hawk a paywalled site and books saying 'Buy here for secrets of retirement investing' or some such.
Fwiw, I myself did a large conversion long ago and have not regretted it. I just thought Edelman's calcs and firm advice were interesting and not suspicious. RMD and heir passalong aside.
The cynical side of me thinks: Paying taxes (Roth IRA) first would reduce AUM for managers like Edelman by the investor's tax rate or between 20-30%. This would equate to a 25-42% loss of profits over a 30 year time frame with a 1% fee schedule comparing a "smaller" Roth IRA to the unconverted "larger" T.IRA...not good for his bottom line.
In the end, the investor may end up with the same results (after taxes), but Edelman would not. He would much prefer to receive 1% from a much larger account balance (tax deferred IRAs) hence the real reason for his answer.
Ya know - I've never considered that. If I were a big fund house, I'd rather be collecting my 1 or 2% (or whatever) ER on somebody's largerbefore tax Traditional IRA than on their smallerafter tax Roth IRA. I can't see how that wouldn't warp my thinking when rendering advice about the benefits of one over the other. And to tell the truth, none of the conversions were easy to accomplish. In one of them I encountered roadblocks and incorrect answers during the process. I can't say they were intentionally making the conversion difficult. But, they sure weren't going out of their way to make it easy. Since the funding for the tax liability did not come from the account being converted, it was in effect a mute point. But it still leaves me wondering. Thanks bee.
We've all heard of the Peter Principle. Maybe at some houses the least capable "associates" get promoted to the Roth Conversion department.
In the discussion portion of a @PRESSmUP link I found this Optimal Retirement Planner:
/blockquote>
Bee...that's a pretty handy worksheet. I spoke to my rep at Schwab earlier in the week about planning a Roth conversion strategy. I am going to see if we can wrap into this a more robust discussion involving withdrawal strategies and even HSA. I think an external resource may be involved.
PRESSmUP , for what it's worth, my Schwab financial guy told me Schwab does not offer HSA accounts. Digging a little more, I found none of the big supermarket brokerages do. I have not found a good place to set up an HSA that can invest in much else than a money market account, without paying a fee to do so. Hence, my HSA money sits in a very low paying Federal Credit Union savings account.
PRESSmUP , for what it's worth, my Schwab financial guy told me Schwab does not offer HSA accounts. Digging a little more, I found none of the big supermarket brokerages do. I have not found a good place to set up an HSA that can invest in much else than a money market account, without paying a fee to do so. Hence, my HSA money sits in a very low paying Federal Credit Union savings account.
Actually, This not a bad thing. The record keeping and convenience of a "cash" account is something I miss at my HSA (with Bruce Funds). Trustee to Trustee transfers are easy with an HSA so after funding your Credit Union HSA consider and HSA with another institution. Bruce Fund is a one trick pony with spartan fees ($15 account fee/yr), but here are some other links to HSA mutual fund investment choices:
Thank you bee. I will look at what's available. I've considered keeping 2 accounts, the saving one that I use for today's expenses and one more as a retirement investment vehicle.
Just a little disagreement with the dividendgrowthinvestor site that says:
"After age of 65, withdrawals are tax-free for any type of distribution from the account."
They are still subject to taxation similar to traditional IRA's if used for regular withdrawals. Just not subject to the 20% penalty. Of course, if used for medical expenses then the withdrawals are tax free, as they have been at any age. And, if you kept the records, you can always match them to medical bills paid in the past with non HSA funds...
Thanks for outside of the box thinking, in general but especially related to HSA's.
Thank you bee. I will look at what's available. I've considered keeping 2 accounts, the saving one that I use for today's expenses and one more as a retirement investment vehicle.
Mike,
I didn't peruse the links provided above but my employer uses healthequity as it's HSA provider and it requires $2000 in liquid cash, then anything over you may invest in a variety of funds.
(Aside: Unfortunately, the new fiduciary law/rules made them switch to exclusively vanguard index funds....)
Thanks Graust , I checked out their web site. I can't find where to find their fee structure, which usually keeps me from going anyplace other than the credit union I'm at not (no fees). I sent them an email asking what fees applied to their HSA's.
"Unfortunately, the new fiduciary law/rules made them switch to exclusively vanguard index funds" (Graust), and
" I can't find where to find their fee structure" (MikeM)
HealthEquity does not make things easy or clear. You wouldn't know that they have two different HSA programs. Of course the fees for any of these programs may be different when sold to different employers (further confusing matters), but I assume we're interested in HSA plans offered directly to individuals.
They had offered an HSA with a variety of funds from different families. This product was called HealthEquity Self-driven, which required you to keep a $2K cash balance and appeared to offer "Investor Choice" funds (for an extra 40 basis pts/year) and Best-in-class funds that charged 12b-1 fees instead. (For example, MWTIX was in the former group, MWTRX in the latter.)
About a year ago, HealthEquity started offering a cheaper, Vanguard-only product, called Index Investor HSA. This product appears to charge $36/year plus adding 24 basis points to the fund investments. (Note that despite the name, it offers more than index funds, e.g. VWIAX.)
As Graust noted, HealthEquity appears to be phasing out its broader lineup, using new fiduciary responsibilities as its excuse. (That it is an excuse seems clear from its disclaimer that "in some cases the newer funds may cost more and provide additional revenue to HealthEquity.") Here's the page showing the mapping of old funds into Vanguard funds.
Since that page shows an added per fund charge of 40 basis points, it seems that the old product is being maintained, with its somewhat different fee structure from the new product. You may wind up choosing between $2K in a bank and 40 basis points (old product), or $36/year and 24 basis points (index product). Vanguard fund offerings seem identical (from a cursory look). They are some of the cheapest Vanguard share classes, FWIW.
My feeling is that HSA Authority may offer a better plan, depending on how much you've got invested and how much you value additional flexibility. For $36/year and $1K in the bank but no additional basis points (as near as I can see), you get 17 Vanguard funds (vs. 23 at Health Equity), but a fair variety of other funds as well.
You will be paying a basis point or two extra because the share class is often Admiral, while HealthEquity sometimes offers Institutional class shares.
And, if you kept the records, you can always match them to medical bills paid in the past with non HSA funds...
... unless you used the bills to take itemized medical deductions. (That includes using them to meet the 7.5% or 10% threshold to itemize other medical expenses.)
Comments
IRS Notice: https://www.irs.gov/irb/2008-25_IRB/ar09.html#d0e797 Once you reach Medicare age, conversions can similarly affect premium costs. Currently, if your MAGI (which includes tax free income like muni interest but not Roth distributions) exceeds $85K for an individual (or $170K for a couple), you're subject to a Medicare surcharge, called IRMAA. This applies to both parts B and D. A common strategy here is to make multiple conversions over the course of the year (assuming you're not planning to convert everything in the current year) and then next April recharacterize ("unconvert") the ones where you did the worst. You keep the conversion(s) where your investment went up the most, and undo the others. Just make sure that you convert into separate Roths, because the IRS looks at how the total Roth performed in computing how much you undo, not just how much one particular fund did. To keep the performance figures "pure", keep the Roths separate.
In subsequent years individual have to find other funding sources. HSA can be funded with both earned and unearned income so a retiree can use a portion of their unearned income to fund their HSA and lower their taxable income dollar for dollar (as a tax credit). Most other IRAs require earned income as the "funding source", HSA do not.
For individuals/couples who would otherwise struggle to find a funding source to fund an HSA (too much month at the end of the pension check), one becomes available at age 59.5 in the form of your T.IRA.
Take a T. IRA taxable distribution equal to your HSA contribution. The two offset one another with regard to taxes, one is a taxable event and the other is a tax credit. For 2017, this "T.IRA to HSA conversion", would amount to $4400 for an individual HSA plan and $7750 for a Family HSA plan (this includes catch-up provision).
A couple could shift about $46K out of the T.IRA into their HSA between the years of 59.5 - 65. At a tax rate of 20% that would save over $9K in taxes that could be used to help pay healthcare costs. They also have shifted $46K out of the T.IRA that will grow tax free and will not impact RMD calculations.
That's a good point, and perhaps the only situation in which funding an HSA out of a traditional IRA makes sense.
So long as you have available cash, and income (earned or otherwise) that the HSA contribution would offset, it is better to use that cash. That's because you wind up with more sheltered money.
But if you don't have the spare cash available, funding out of the IRA can serve as pseudo-Roth conversion.
Or never:
http://www.edelmanfinancial.com/education-center/articles/q/qa-roth-ira-conversions-and-taxes
Paying taxes (Roth IRA) first would reduce AUM for managers like Edelman by the investor's tax rate or between 20-30%. This would equate to a 25-42% loss of profits over a 30 year time frame with a 1% fee schedule comparing a "smaller" Roth IRA to the unconverted "larger" T.IRA...not good for his bottom line.
In the end, the investor may end up with the same results (after taxes), but Edelman would not. He would much prefer to receive 1% from a much larger account balance (tax deferred IRAs) hence the real reason for his answer.
Note:
"Congress (has) imposed a special rule. If you take a distribution from the conversion money in your Roth IRA within five years after the conversion, the early distribution penalty will apply even though the distribution isn’t taxable. Example: You convert your traditional IRA, with a value of $20,000, to a Roth IRA, paying tax on the entire amount. Two years later, when you are under age 59½, you withdraw $5,000 from the Roth IRA, and the distribution comes from conversion money because you haven’t made any regular contributions to your Roth IRA. The distribution isn’t taxable because you already paid tax on that amount in the year of the conversion. You owe a $500 early distribution penalty, though, (10% of $5,000) unless you qualify for one of the exceptions (such as disability or medical expenses)."
http://fairmark.com/retirement/roth-accounts/roth-distributions/distributions-after-a-roth-ira-conversion/
I've done 3 conversions during the past decade. Aside from the question of whether the early tax hit is off-set by the tax exemption of future growth (Davidmoran's point), there are other advantages for which it's difficult to assign a monetary value (bee's point):
- If you're fortunate enough to convert an asset near its market bottom (easier said than done) you do very well because the eventual sharp rebound in value is exempt from whatever type of tax would have applied to it outside the Roth. This worked quite well for 2 of the 3 conversions I did. (The 3rd is slightly ahead after 2 years).
- As bee says, there are no RMD requirements (that I know of) for Roths.
- If you have Traditional IRAs at multiple custodians, you can simplify your tax preparation (but not lessen your tax bill) by converting all but one account to Roth status. Without even planning to do this, I'm pleased that because of the conversions, my Traditional IRA is solely with one custodian.
I'm not a purist - so have taken distributions from both the Traditional and the Roths in recent years. However, I'd agree with the others that ideally one take distributions from the Traditional first.
Advice: Try to keep conversions separate by year so you can easily keep track of the 5-year restriction. In other words, do one at Custodian A in 2017 and another at Custodian B in 2019. Intermingling different conversions - especially within the 5 year window - can really complicate tax preparation.
"The Optimal Retirement Planner (ORP) computes your tax-efficient schedule of retirement savings withdrawals for your entire planned retirement. Withdrawals from your Tax-deferred account (401K, IRA, SEP...) are subject to the Federal progressive personal income tax. The order in which you make withdrawals from your Tax-deferred, Roth IRA, and After-tax accounts affects your total retirement disposable income."
https://i-orp.com/
TAX-EFFICIENT WITHDRAWAL STRATEGIES
http://www.cfapubs.org/doi/pdf/10.2469/faj.v71.n2.2
@bee,
If your cynicism and imputation of bad faith / fee grubbing were the case, it seems to me Edelman probably would not have offered this advice (backed with math in tax tables) to all comers publicly for over a decade, free, online and over the air. Instead he would hawk a paywalled site and books saying 'Buy here for secrets of retirement investing' or some such.
Fwiw, I myself did a large conversion long ago and have not regretted it. I just thought Edelman's calcs and firm advice were interesting and not suspicious. RMD and heir passalong aside.
We've all heard of the Peter Principle. Maybe at some houses the least capable "associates" get promoted to the Roth Conversion department.
Article (NYTimes) on the investment choice available for HSAs:
nytimes.com/2013/12/12/your-money/shopping-for-a-health-savings-account.html
31 choices (HSASearch):
https://hsasearch.com/
Comparison Tool:
https://hsasearch.com/compare/
HSA Bank
hsabank.com/hsabank/members/hsa-investments
A redirect from Vanuard to here:
healthsavings.com/enroll-now/
Associated Bank:
https://associatedbank.com/personal/savings-and-investing/health-savings-accounts/HSA-investments
Health Savings Account (HSA) for Dividend Investors
dividendgrowthinvestor.com/2015/02/health-savings-account-hsa-for-dividend.html
Betterment Article:
https://betterment.com/resources/life/truth-about-hsas-and-retirement/
Saturna Capital:
saturna.com/individual/hsa/index.shtml
"After age of 65, withdrawals are tax-free for any type of distribution from the account."
They are still subject to taxation similar to traditional IRA's if used for regular withdrawals. Just not subject to the 20% penalty. Of course, if used for medical expenses then the withdrawals are tax free, as they have been at any age. And, if you kept the records, you can always match them to medical bills paid in the past with non HSA funds...
Thanks for outside of the box thinking, in general but especially related to HSA's.
Great thread!!
I didn't peruse the links provided above but my employer uses healthequity as it's HSA provider and it requires $2000 in liquid cash, then anything over you may invest in a variety of funds.
(Aside: Unfortunately, the new fiduciary law/rules made them switch to exclusively vanguard index funds
"Unfortunately, the new fiduciary law/rules made them switch to exclusively vanguard index funds" (Graust), and
" I can't find where to find their fee structure" (MikeM)
HealthEquity does not make things easy or clear. You wouldn't know that they have two different HSA programs. Of course the fees for any of these programs may be different when sold to different employers (further confusing matters), but I assume we're interested in HSA plans offered directly to individuals.
They had offered an HSA with a variety of funds from different families. This product was called HealthEquity Self-driven, which required you to keep a $2K cash balance and appeared to offer "Investor Choice" funds (for an extra 40 basis pts/year) and Best-in-class funds that charged 12b-1 fees instead. (For example, MWTIX was in the former group, MWTRX in the latter.)
About a year ago, HealthEquity started offering a cheaper, Vanguard-only product, called Index Investor HSA. This product appears to charge $36/year plus adding 24 basis points to the fund investments. (Note that despite the name, it offers more than index funds, e.g. VWIAX.)
As Graust noted, HealthEquity appears to be phasing out its broader lineup, using new fiduciary responsibilities as its excuse. (That it is an excuse seems clear from its disclaimer that "in some cases the newer funds may cost more and provide additional revenue to HealthEquity.") Here's the page showing the mapping of old funds into Vanguard funds.
Since that page shows an added per fund charge of 40 basis points, it seems that the old product is being maintained, with its somewhat different fee structure from the new product. You may wind up choosing between $2K in a bank and 40 basis points (old product), or $36/year and 24 basis points (index product). Vanguard fund offerings seem identical (from a cursory look). They are some of the cheapest Vanguard share classes, FWIW.
My feeling is that HSA Authority may offer a better plan, depending on how much you've got invested and how much you value additional flexibility. For $36/year and $1K in the bank but no additional basis points (as near as I can see), you get 17 Vanguard funds (vs. 23 at Health Equity), but a fair variety of other funds as well.
You will be paying a basis point or two extra because the share class is often Admiral, while HealthEquity sometimes offers Institutional class shares.