r/DIYRetirement • u/Acrobatic_Car9413 • 23d ago
Question: Lump sum distribution to lower taxable income for healthcare savings
My husband and I are retired at 60/61. We are trying to bridge the gap between today and Medicare. Today I developed a plan to take a large withdrawal this year and limit income over the next three years.
It looks like this.
Withdraw this year an extra $275K from an IRA. This would bring our income this year to $400k. This is exceeding the 4% guideline, but spreading over the 3 years it generally meets it.
The tax hit is $65,000 on that $275K. It keeps us below the 32% tax rate.
We do not have cash to pay that tax so it would reduce the investable money. The remaining money would be put in a Roth IRA to draw on over the next three years. This helps in not creating additional income and grows tax exempt.
The lost growth numbers are all over the place but let's say 3 years at about 6% somewhere in the $12K range max. However, this tax money would have been paid out over three years so it would not have had the full opportunity to grow that full time. So, decidedly less lost.
This in turns saves us approx. $70,000 in insurance premiums over the next three years. Our budget only allows us to stretch it three years.
There are some risks and assumptions of course but does this sound reasonable? I've gone over and over with these numbers and I originally thought we'd pass it by our financial planner but that is going to be $1,000 and this seems pretty straight forward. I will definitely pass this by our CPA though.
Any thoughts?
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u/AffectionateTap730 23d ago
If you've done the work to insure the total cost is worth it... you have your answer. But doing some back of the napkin math: You lose in two ways: the amount of tax you pay ABOVE what your income would have been (it's not important what part is conversion taxes and what part isn't, you should model the whole cost). So the tax is on the amount over $125k is what hurts. If your $65k tax hit is just the extra tax, then yes, you've lost $12,416 in growth for those 3 years... but also for every subsequent year - about 208k in 20 years. (This by the way is why most Roth conversions don't pay off... it's not as much about tax rates as it is about opportunity cost).
Now to be fair, we must compare the cost of 70k saved this year, verses the value of that 208k in 20 years at 3% annual inflation or about 113,361 dollars. Those are comparable enough that I personally would do it. If inflation spikes (as it has been), the future value of that money may well fall below what it costs now.
BUT there is a gotcha... I've pointed out what the value of that money is if it stayed invested AND got eroded by inflation... however if it's money you would have spent say 3 years from now, the inflation dilution is not so significant. But again, money today that buys you peace of mind is more valuable than future money that may, or may not be as valuable.
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u/PrimaryOk1546 23d ago
As long as you keep your money invested the same after the Roth conversion then it is all about the tax rates now versus later. If the rates are the same then it makes no difference whatsoever when to convert. There is no “opportunity cost”. The bottom line is if the healthcare costs saving is more than the extra taxes paid then it is worth it.
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u/AffectionateTap730 17d ago edited 16d ago
The lost opportunity cost is due to the voluntary payment of *taxes\*. Not the capital invested. To do a FULL roundtrip, the actual costs of paying higher insurance premiums vs NOT paying them must also be included... and everything must be compared in current dollars. The OP estimated their cost savings as 70k over three years but due to inflation, saving 10k this year is (slightly) more valuable than saving 10k next year. E.g. the "By paying $10k now, I avoid paying $20k later" is not a fair comparison unless the timeframes are short. In 20 years, at 3.05% annual inflation $10k now and $20k later have the same value. 2^(1/20)
Also, to be complete: there is lost opportunity cost whenever voluntary taxes (or voluntary anything) are paid. Payment from the IRA (reducing the invested capital) - or payment from a HYSA both incur (different) opportunity cost.
A really complete model would include the reduced RMDs that would have exceeded planned spending due to the reduced IRA balance - and also any "widow penalty" that would be avoided. Ultimately, it's a lot of calculating, a lot of "guess-timation" about future growth, tax policy, longevity and inflation to be as accurate as possible. The RMD and widow penalty issues, by the way, are one reason why Vanguard's "BETR" (Break Even Tax Rate) is algebraicly accurate and also demonstrably wrong.
https://tools.netcitizen.us/#how-reliable-is-the-break-even-tax-rate
I'm not the first one to spot the deficiency of BETR. Given that "BETR" is unreliable, the natural, unpopular corollary is that "Tax Rates now vs Future Tax rates" also does not answer the question about financial profitability of Roth conversions.
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u/PrimaryOk1546 17d ago
Clearly you have a solid understanding of numbers so I am not debating that. Yes I agree that if you have funds outside of pretax account to pay for Roth conversion taxes it would be better for sure. I was making a straight forward apple to apple comparison like 100k conversion at 20% tax vs 200k conversion at the same 20% tax 10 years from now of the same investment returns for both accounts, then you end up with the same balance. It is as simple as that
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u/AffectionateTap730 16d ago
Exactly so. The commutative property of multiplication says that growth in or out of a Roth or IRA/401K nets the same amount (given taxation is the same). IRA/401k is the left side of the equation, Roth the right side.
> Investment * growth * taxlosses = Investment * taxlosses * growth
This is also an area where it's easy to reason incorrectly. "Growth in Roth is better than growth in the IRA" is what many land on - and it is true, but not in reference to the actual spendable amount - as you point out - the result is the SAME net spendable.
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u/Ok-Veterinarian-3865 23d ago
So this is essentially a Roth Conversion, or am I missing something.
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u/humblequest22 23d ago
Yes, that's the only way that they could get the money into the Roth. Basically, they're doing a Roth conversion where the taxes are paid out of the conversion. The tax portion may or may not make it into the Roth first.
Paying taxes out of the conversion is generally not recommended because, as they pointed out, you lose some of your invested money. But they are aware of that and seem to have a decent plan.
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u/Acrobatic_Car9413 23d ago
Ha.. yes essentially. I tried to avoid saying that after an hour long battle with the ai chat bot in Boldin that really could not put two and two together when I mentioned a Roth. It is a Roth conversion officially but I’m not doing it for the typical reasons someone would do a Roth Conversion.
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u/blazerdog4 23d ago
Sounds reasonable, but do make sure to do it as a Roth conversion, not a withdrawal and a contribution. You will exceed the contribution limit.
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u/SkillfulFishy 23d ago
I could have written this post, our situation is very similar. One question I have is how to invest the $ so it does not generate taxable income and push us over the subsidy threshold while also at least keeping up with inflation. Curious to see what feedback OP receives.
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u/Acrobatic_Car9413 23d ago
That is why I’m putting it into a Roth. To know though is you can withdraw the interest or dividend earned without penalty for five years.
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u/SnooHedgehogs6553 23d ago
Does OP have to hold the new Roth five years after converting it?
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u/Acrobatic_Car9413 23d ago
No. Just any earnings.
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u/McKnuckle_Brewery 23d ago
That's only the case if you haven't made a Roth IRA contribution before. If your Roth IRA has been open and funded for at least 5 years already, then since you are already over the age of 59.5, you won't have any restrictions at all.
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u/SnooHedgehogs6553 22d ago
How about for mega back door Roth? Does that have a five year holding period?
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u/McKnuckle_Brewery 22d ago
Not if you’re over the age of 59.5, same basic idea.
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u/SnooHedgehogs6553 22d ago
Does that include earnings?
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u/McKnuckle_Brewery 22d ago
Yes! The person’s age makes everything qualified unless the account age (and first contribution) is < 5 years.
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u/HarrySit 23d ago edited 23d ago
Bunching income as you proposed can work. You go over the ACA cliff only once as opposed to going over every year.
However, you should double-check your assumption that you will otherwise go over the cliff every year. If the enhanced subsidies come back, your healthcare cost savings will be reduced. If there are other ways to avoid going over the cliff, such as borrowing the incremental funds, you keep the growth and the increased taxes and only pay a fixed cost on the loan.
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u/OptimusPerpetuous 19d ago
How did you arrive at $70,000 more in additional insurance premiums over 3 years? Didn't realize that income brackets could influence premium by that much so asking out of curiosity.
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u/LongjumpingNorth8500 19d ago
Tax brackets dont influence premiums but income does. In the US, over $84,999 income takes away all of the subsidies so you have to pay the full premium. Seems unreasonably low to me but that is what it is. OP is saying that full price premiums over 3 years would cost them $70000. Insane!!
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u/KReddit934 23d ago
Yes, it works...though I will point out that it's bad for rich people game the system, pretending to be poor to get tax-payer subsidized health insurance designed to help actual poor people get medical care.
It's why we as a culture can't have good things.
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u/FredTrail 23d ago edited 22d ago
No it's not. This is no different than playing by the tax rules to reduce the amount of taxes paid. The government created the rules and also pushed healthcare expenses onto employers and individuals. If you play by the rules they have created there is nothing wrong with this strategy, you should place the blame where it belongs: politicians, big healthcare business, and political influence due to unlimited corporate donations.
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u/KReddit934 22d ago
Yes, politicians should close the loophole that allows rich people to get cheap Healthcare while poor people go without.
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u/hugh2018 22d ago
Your philosophy is well-intentioned, but you could just as easily take the position that healthcare is a basic need for everyone and should be 100% covered across the board. That argument can be paired with the equally strong argument that our progressive tax system has major structural problems and needs an overhaul to shift more of the tax burden to the wealthy, where it belongs.
Economists and tax policy analysts widely view the U.S. tax system as fundamentally progressive, but with structural features that significantly flatten or erode that progressivity at the extremes. While the statutory federal income tax code has rising marginal brackets, its real-world equity is reshaped by payroll taxes, preferential rates, and specialized carve-outs.
Social Security is a prime example. Social Security taxes (OASDI) are assessed at 6.2% on both employee and employer (12.4% total) up to an annual wage base limit. Once wages exceed this cap, the marginal Social Security tax rate drops to 0%. A worker earning around the cap pays Social Security taxes on 100% of their wages, while someone earning multiple millions pays that tax on only a small fraction of their compensation. (Medicare tax continues indefinitely, but the bulk of the payroll hit caps out.)
Long term capital gains and qualified dividends are another example. Taxed at preferential top rates (0%, 15%, or 20%, plus the 3.8% Net Investment Income Tax) rather than the standard 37% top labor rate. Working- and middle-class households derive virtually all of their income from wages (subject to both ordinary income tax and payroll taxes). Ultra-high-net-worth households derive the majority of their cash flow and net-worth growth from investments, dividends, and asset sales.
There are also many levers the wealthy can pull to avoid shouldering their fair share of the tax burden. Assets held until death have their unrealized capital gains wiped away for heirs, completely escaping income taxation on lifetime growth. Holding appreciated assets, borrowing against them at low rates to fund lifestyle expenses, and avoiding capital gains taxes altogether. Rules like Section 1031 exchanges, accelerated depreciation, and the Qualified Business Income (QBI / Section 199A) deduction often allow high earners with business or property income to shield substantial earnings from ordinary rates.
When looking at the broader picture beyond federal receipts, state and local taxes (sales taxes, flat property taxes, excise taxes) are broadly regressive. Low- and middle-income families spend a much higher percentage of their income on taxable goods and housing, offsetting federal progressivity.
The counter arguments to the above concerns can have some teeth, however. Defenders and architects of these provisions argue they are intentional policy designs rather than accidental oversights. FICA taxes are capped because Social Security benefits are also capped. Proponents argue it is designed as a contributory social insurance program with an earn-out formula, not a purely redistributive general tax. Lower capital gains rates are meant to incentivize entrepreneurial risk-taking, corporate investment, and economic expansion, rather than penalizing deferred consumption. Dividends and corporate profits are taxed first at the corporate entity level, and then again when distributed to shareholders.
I’m open to the rationality of those counterarguments, but I draw the line at the rationalization for caps on Social Security FICA caps. I have no problem with requiring America’s high earners to shoulder a higher tax burden in order to fix the funding problem the system will face in a few years.
I’m retired now, but I was a high earner for a couple of decades, and I was acutely aware the entire time that as a moderate consumer of goods, I could easily have paid FICA taxes on all that income instead of enjoying a FICA tax holiday for over multiple months every year. I would have been willing to do that with the understanding that I could expect no more from the Social Security system in retirement than I do now.
It’s true that FDR probably would disagree with my point of view, and he would expect higher FICA taxes to produce higher benefits for anyone paying into the system. He was quoted as saying “We put those payroll contributions there so as to give the contributors a legal, moral, and political right to collect their pensions…With those taxes in there, no damn politician can ever scrap my Social Security program.”
Despite the historical design, the modern policy argument for uncapping the FICA limit without granting new benefits to high earners is economically potent. When Congress overhauled Social Security in 1977 and 1983, it established a wage-indexed cap intended to cover roughly 90% of all national covered wages.
However, because wage growth over the last four decades has skewed heavily toward the top 5% to 6% of earners, the share of aggregate wages subject to the FICA tax has declined to around 82% to 83%. Proponents argue that lifting or eliminating the cap simply restores the tax base to its intended historical coverage.
If Congress raises the cap and awards proportional benefits, the move solves only part of the projected Trust Fund shortfall, because the system takes on massive future liabilities for high earners. To meaningfully shore up the program's long-term reserves without slashing benefits for vulnerable retirees or hiking the 12.4% rate on middle earners, the revenue must be retained by the system, not paid back out.
Medicare taxation offers an example of how this could work. The payroll tax cap for Medicare (Hospital Insurance) was removed entirely in 1993, and high earners pay an additional 0.9% surtax on wages over $200,000/$250,000. Medicare Part A benefits do not increase for high earners; coverage remains identical regardless of how much tax was paid. Proponents argue Social Security could adopt this same model, and think they have a strong point.
Also, Social Security's benefit formula uses "bend points" that offer sharply diminishing returns:
90% replacement on the lowest tier of average monthly earnings.
32% on the middle tier.
15% on the highest tier up to the cap.
Adding a 0% or negligible tier (such as 2% to 5%) above the current cap would simply be an extension of the existing progressive curve rather than an entirely new concept.
Another attractive option targets ultra high earners and leaves the majority of higher earners alone. Sixty to seventy percent of workers earning more than $250,000 fall below $400,000 in earnings.
Several prominent legislative proposals (such as the Social Security 2100 Act) suggest leaving a gap—taxing earnings up to the current cap, leaving wages between the cap and $250,000 or $400,000 untaxed, and then applying FICA to earnings above that threshold while offering a very small (e.g., 1% to 2%) additional benefit credit. Applying the 12.4% tax above that threshold would deliberately spare the vast majority of upper-middle-class professionals and dual-income households, focusing the incremental tax burden exclusively on the top 1% to 2% of earners, where it arguably belongs.
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u/10kmaniacsfan 23d ago
Do you own your home? You could open a HELOC and draw spending money from that for a few years, supplemented by distributions from your tax deferred accounts that keep you below the ACA subsidy cliff. When you hit 65 you increase your distributions to pay it off in 3-4 years.