After doing some more research I’ve found a few snags and caveats in the first-draft tax-free retirement plan I posted . These are the most concerning ones:
- I planned that in a couple of years, I would drop my adjusted gross income considerably for a few years because I will have fewer tax credits I can play off against taxable income to get my tax rate down to zero. This is fine from a spending point of view, because I will be able to tap some additional income that does not appear in AGI. However, this threatens to push me out of the Covered California subsidized health insurance marketplace and onto its health-insurance-for-poor-people plan (Medi-Cal). If that were to happen, I would lose my high-deductible health insurance plan and would no longer be able to contribute to a health savings account. That would eliminate a nice tax deduction and also a good tax-free way of paying for health expenses later on in retirement, so I would like to avoid that if possible.
- Apparently you cannot use any portion of your required minimum distribution from an IRA to make Roth conversions. I hadn’t accounted for that in my original plan.
- The “combined income” factor that determines how much of my social security benefit becomes part of my adjusted gross income, and so potentially my taxable income, does not adjust for inflation under current law. Currently, if my CI is below $25k, none of my social security is taxable; if it is higher than that but below $34k, 85% is taxable; if it is higher than that, 100% is taxable. But those thresholds are set in stone by current law; if nothing changes, they will be the same in when I turn 70. In order to keep my CI that low, my spending budget has to stay low to match, but money won’t go as far then, so that represents a significant hit.
- Oh yeah, about that social security: Currently, the social security program is scheduled to start running short of money in , before I plan to start taking benefits. If nothing is done to fix this problem, benefits could drop to about three quarters of their currently-anticipated values.
Here are some thoughts on how I might address these conundrums:
- (Low AGI=no HSA)
There are a few options here:
- I could just take the hit and go on Medi-Cal. The loss of the deduction would mean I would withdraw less from my IRA during the years when I had intended to fund the HSA. Having less money in the HSA would mean I would have to pay for medical expenses from IRA withdrawals or from social security in my early 70s instead. Neither of those things breaks my plan, but it makes my zero-tax budgets slightly tighter.
- I could let my AGI climb out of the zero-tax zone and take the federal tax hit. After all, I’ve been owing (and neglecting to pay) self-employment tax for years. If I were to owe and not pay a smaller amount of income tax, that would for practical purposes amount to the same policy I’ve long been operating under.
- I could withdraw enough money from my IRA to raise my AGI sufficiently, but then spend that extra money on courses at the university up the street. That way I could qualify for the federal “Lifetime Learning Credit” with which I could eliminate any tax due on the higher income. That university has a good set of courses on artificial intelligence in its computer science department, and on the ethics of technology in its philosophy department, which both seem like good bets for positioning myself to be more capable to contribute meaningfully to humanity’s attempts to weather the incoming crisis. This currently seems like the most attractive option.
- (RMDs and Roth conversions)
My options here appear to be two:
- Stop making Roth conversions and have to start taking RMDs. Turns out that’s no big deal and doesn’t really change my plan much at all.
- Take additional IRA withdrawals over and above the RMDs in order to make Roth conversions. I don’t think this is worth doing.
- (CI not indexed for inflation) I don’t have a plan for how to deal with this. The ramifications do not begin until , which is far enough out that I assume the law will change in some meaningful way by then, whether for the worse or the better, and I’m better off waiting to cross that bridge when I come to it.
- (Social Security unsustainable) If this happens, this will result in slimmer budgets for me during my social security years (after age 70), but nothing unendurable. However, as with the previous item, I assume that by then the law will have changed in some way. The politicians in Congress aren’t about to let every voter on social security take an abrupt 20% cut without trying to cook the books in some manner. Someone will have to get screwed to prevent that from happening, and I might very well be one of the someones, but it probably won’t be in the manner this scenario suggests.
OK. I’m getting pretty tired of running all these numbers, but I wanted to be extra careful to get things right. With much of the above (and several other smaller tweaks) incorporated into my game-plan, here’s how it’s shaking out now:
| ages | 0-tax target | strategy |
|---|---|---|
| 57½–59½ | AGI < $17,100 | Limited Liquidity: Spend down cash, use mature Roth principal to supplement. Continue maximum deposit to HSA. Do Roth conversions to fill out your 0% bracket. Pay medical expenses without dipping into the HSA. Continue ~$5k/year charitable contributions. Your post-medical spending budget is ~$30–35/year. |
| 59½–65 | AGI ~$23,000 | IRAs available: Tap tax-deferred IRA to get to the minimum AGI necessary to keep your health plan (~$29–$30k/year). Beyond that, pull from the Roth (~$18k/year). Continue maximum deposit to HSA. Pay medical expenses without dipping into the HSA. Continue ~$5k/year charitable contributions. Your post-medical spending budget is ~$35–36k/year but you’ll need to spend $4–5k of that on university courses to qualify for the Lifetime Learning Credit to bring your federal income tax down to zero. |
| 65–69 | AGI < $20,050 | Medicare: You must join Medicare, so you lose the health insurance plan that allows HSA contributions. Pull annually about $21k from your traditional IRA, and $18–19k from your Roth. Medical expenses are likely to rise (Medicare premiums and deductibles); budget about $6.5k for this, but pay from your HSA. Continue to make charitable donations until the last tax debt vanishes in 2037. Your post-medical spending budget is ~$33–35k/year. |
| 70–74 | CI < $25,000 | Social Security: You begin taking Social Security, about $35k per year (Congress willing). Withdraw about $17k per year from your IRA, but donate the bulk of that ($15k) via “qualified charitable donations” to keep your combined income below the (hopefully similar to today) 0% threshold. In addition, do $5k/year in Roth conversions, as this will come in handy when your HSA gives out. Your post-medical spending budget is ~$37k/year. |
| 75+ | CI < $25,000 | Required Minimum Distributions: The required minimum distributions do not change the pace of your traditional IRA withdrawals very much, putting them in the $18k–25k per year range. In addition, you can take $1–2k per year from your Roth; more if you have reason to expect your dreams/nightmares of living into your 90s will be thwarted. Your HSA is depleted or soon will be, so you’ll be paying for medical expenses out of your IRA withdrawals instead. Stop doing Roth conversions. Keep up your qualified charitable donations of $12k–$18k per year to keep your combined income sufficiently low. Your post-medical spending budget is ~$36–38k/year. |
