Bogleheads University 501 2023 - Roth Conversion and Retirement Tax Planning with Wade Pfau

Episode Overview

• Wade Pfau explains how to create a more tax-efficient retirement by strategically managing withdrawals and Roth conversions, moving beyond the conventional wisdom.
• The presentation breaks down the complex, non-linear nature of the U.S. tax code for retirees, highlighting hidden "tax traps" that can dramatically increase effective marginal tax rates.
• Pfau introduces the concept of "tax maps" to visualize the tax "roller coaster," helping retirees identify opportunities to pay taxes at lower rates.
• The core strategy involves "front-loading" taxes through Roth conversions during low-income "gap years" to reduce the impact of future Required Minimum Distributions (RMDs) and increase long-term, after-tax wealth.

Key Concepts

• Tax-Efficiency and Portfolio Longevity: Being smart about the order and timing of retirement withdrawals can have a significant positive impact on how long your portfolio lasts and the after-tax value you can leave to heirs.
• The "Tax Roller Coaster": Effective marginal tax rates in retirement are not linear. They jump up and down unpredictably due to various factors stacking on top of each other, such as the taxation of Social Security benefits (the "tax torpedo"), Medicare IRMAA premium surcharges, and how capital gains are taxed.
• Conventional Wisdom vs. A Better Approach: The standard advice is to withdraw from taxable, then tax-deferred, then tax-exempt accounts. A better approach is to proactively "fill up" lower tax brackets with income (via Roth conversions) during low-income years to avoid being forced into very high marginal tax brackets later by RMDs.
• Roth Conversions as a Tool: Roth conversions are a primary method for this strategy. By converting funds from a Traditional IRA to a Roth IRA, you pay income tax now, ideally at a lower rate, to create a source of tax-free income for the future and reduce the size of your future RMDs.
• The "Gap Years": A crucial window of opportunity for tax planning exists in the years between retirement and the start of Social Security and RMDs (typically in one's 60s). During this time, retirees often have their lowest income, making it the ideal period for strategic Roth conversions.

Quotes

• At 01:42 - "Tax-efficiency can have a significant impact on portfolio longevity." - Wade Pfau states the main premise of his talk, emphasizing that these strategies are not just about minor savings but can fundamentally change retirement outcomes.
• At 02:07 - "Pay taxes when rates are low, avoid taxes when rates are high." - Pfau articulates the simple, guiding principle behind complex tax-efficient withdrawal strategies.
• At 18:32 - "This is the roller coaster. Your effective marginal tax rate goes up and down as you're generating more income, and it can be a lot higher than what the federal income tax brackets look like." - Pfau explains his "tax map" concept, showing how various surcharges and phase-ins create unexpected spikes in the tax rate paid on each additional dollar of income.

Takeaways

• Do not automatically follow the conventional withdrawal order (taxable, then tax-deferred, then Roth); a more dynamic approach tailored to your marginal tax rate each year is often superior.
• Identify your "gap years" between retirement and age 70 (or whenever you plan to take Social Security/RMDs) as a prime opportunity for Roth conversions while your income is low.
• Understand that an extra dollar of income (like from an IRA withdrawal) can cost much more than the stated tax bracket due to cascading effects like triggering Social Security taxes or higher Medicare premiums.
• Consider paying taxes strategically in the short term to create long-term benefits. This "tax-smoothing" approach helps avoid being forced by RMDs to realize large amounts of income at very high marginal rates later in retirement.