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March 19, 2008

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Steve Austin

Hey, Early Retirement Extreme sent me over here to cause some trouble. ;-\

I am enjoying the tax tips you are laying out, and am in a similar position as you and taking similar steps. I early-retired in 2006, and did the 401(k) front-loading for 2003 through 2006, because I was never sure which year I was going to punch out. I also found that nysscpa article several years ago, and used it to very carefully plan my tax life starting this year. Did you roll your 401(k) into a Rollover IRA already? That was the first thing I did, day of ceasing employment.

Wanted to mention that the 2008-2010 zero rate applies to qualified dividends as well. Have to say that I was a little concerned when I read that you intend to spend down your taxable accounts between now and 59.5. Why not invest with an eye to at the very least maintaining your taxable account, if not growing it? Speaking of dividends, there are some great yields out there right now, BAC being one of my favorites, had been pushing 7% current yield earlier this week.

Also, a question for you from part 3: why not enjoy the zero rate cap gains AND do the partial rollover conversion of your IRA to your Roth IRA? I'm doing both, so let me run the scenario by you (you being the Tax-CPA expert) and have you vet it for any snags, if you don't mind:

* filing single, so my magic number is $32500 as you pointed out
* deduction & exemption are $8950
* est. taxable interest income of $1200
* taxable rollover conversion income of $7750 [1]
* est. municipal bond int. income + qualified div. income $16500
* est. L-T cap. gain income $7100 [2]
=====================================
* est. total income of $32550 but BIG FAT ZERO TAX LIABILITY!!

[1] I'll conduct the rollover conversion in December, after I get a good grasp of what my final taxable interest income will be for the year; idea here is for tax. int. income + tax. rollover conv. income to be as close to $8950 as possible

[2] I'll make a decision on how to effect the $7100 L-T cap. gain in November and December, the idea being that my total income must not exceed $32500, so I may err several hundred bones on the conservative side to make sure I don't screw the pooch. What's great about the L-T cap. gain approach (explained in the nysscpa article) is that even if you still want to hold your stock, you can do a "free" step-up in your cost basis by selling one afternoon, and buying back the next morning. You don't pay any taxes on it this year, and you lower the L-T cap. gains taxes that you'll eventually pay when you *do* want to actually sell (and not repurchase).

I love this free rollover conversion plan. Not only did I not pay taxes on the way in (deductible 401(k) contribs), but I also won't pay on the way out (Roth IRA withdrawals 20+ years down the line).

I'll be watching for your next tax-tip post(s). And if you are so inclined, please vet my 2008 scenario above.

Retired Syd

Steve:

Welcome! Wow, lot's to respond to!

So, yes, I am rolling my 401(k) to the IRA (and then converting to the Roth over the years). The reason I can't do both the IRA and the capital gains stuff both this year and next year, is because of the $100k Modified AGI (MAGI) limit on conversion (that's modified AGI--not taxable income, which is much lower.) Since I worked this year and since I will be selling enough gain stock to get me over the $100k in both these years, I cannot take advantage of both at the same time until the "MAGI" limit is removed for IRA conversions in 2010.

As to spending down my assets. The truth is, I'm not planning on exhausting these until age 63, but was keeping the post very general. My retirement projections say that if I only make 5% on those taxable assets (I'm trying to assume low and hope the market performs better than my projections) then I will need to switch to retirement assets at age 63. However, to the extent that this earnings assumption is low (which I hope), I won't have to switch until later.

I have no need to die with assets, so after the switch to retirement assets (which should last until age 95), there won't be a whole lot left when I kick the bucket--(and I'll need to do better than my assumed rate of return or cut back expenses if it looks like both of us--my husband AND I--are going to make it past 95!)

Now, on to your individual question. Looks like you are in good shape, in fact, better than you think. First, when I add you income numbers above I get 32,550 AGI--then after deductions $23,600 of taxable income, so it looks to me like you've got a bit more room to convert of sell long-term gain property. Also, you combined Cal Muni's and dividends in your question, but Cal Muni's are not taxable--so it looks like you have even a bit more room!

Of course you are always best off visiting a "real" working CPA for tax advice but hopefully this is at least a little helpful.

Steve Austin

RS, thanks for elaborating on your rollover conversion plans, I understand the situation now. I can see where it makes sense to max out the zero rate on L-T cap gains while it lasts, and then exploit the 2-year tax liability for a Roth rollover conversion in 2010(-2011). I didn't even consider the MAGI limit, because I'm not anywhere close to it. ;-\

I follow what you're saying re: your taxable account drawdown. Sounds like you do have some slop built in (conservative depletion by age 63 vis age 59.5). I suppose I like to be conservative in perpetuity, having a slug of taxable assets that grows faster than I draw from it, to use for a large emergency. e.g. if I don't have anyone to take care of me at age 95, would have to pay for long-term care or an assistant or something labor-intensive like that. That way, I won't touch my Roth IRA or Rollover IRA, other than what I had planned for routine, recurring expenses. I.e. in an emergency, I don't want to have to dip into my tax-advantaged accounts. Besides, I like to have my Rollover IRA intact (with at least $125,000) so that I can continue to use rollover conversion contributions from it as offsets to my standard deduction & personal exemption. ;-\

Thank you for quality-checking my rough plan -- you saved me $1500-2000! (Depends on whether one presumes a future 15% or 20% L-T cap gains rate on the additional $10000 that I would have incurred if I had not realized it this year.) My muni bond funds are national; I am domiciled in a non-income tax state. But you're right I should not include them in this equation at all. Here is my revised plan

* single, 15% marginal rate, income limit $32550
* deduction & exemption are $8950
* est. taxable interest income of no more than $1200
* taxable rollover conversion income of at least $7750
* est. qualified div. income $14200
* est. L-T cap. gain income $18350
---------------------------------------------------
* est. total taxable income of $32550
* est. tax-exempt municipal bond interest of $2250
===================================================
* est. total income of $34,800 : zero tax liability

[also have some good income in my IRA and RIRA, but not relevant to this discussion]

So I owe you a beverage. ;-\ And I always trust volunteer advice more than paid advice. Volunteers do it because they want to; paid advisors do it because you want them to. I do my own due diligence anyway, so best course for me is to collect and synthesize free advice for my own purposes.

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