Tax Lab methodology

What Methodology is Used to Produce Tax Lab Analysis?

Once you have a retirement income and distribution plan designed, the Income Lab Tax Lab allows you to explore the following questions:

1. How should the client source and sequence portfolio withdrawals?
2. Should the client consider Roth conversions?

To do this, the software simultaneously runs 20 ways to source portfolio withdrawals, while keeping other parts of the plan (Social Security timing, etc.) constant.

1. Pro-Rata
2. Taxable, Tax-Deferred, Tax-Free*
3. Taxable, Tax-Free, Tax-Deferred
4. Tax-Deferred, Taxable, Tax-Free
5. Tax-Deferred, Tax-Free, Taxable
6. Tax-Free, Tax-Deferred, Taxable
7. Tax-Free, Taxable, Tax-Deferred
8. Roth conversions to fill 0% bracket
9. Roth conversions to fill 10% bracket
10. Roth conversions to fill 12% bracket
11. Roth conversions below IRMAA Brkt 1
12. Roth conversions to fill 22% bracket
13. Roth conversions below IRMAA Brkt 2
14. Roth conversions below IRMAA Brkt 3
15. Roth conversions below IRMAA Brkt 4
16. Roth conversions to fill 24% bracket
17. Roth conversions to fill 32% bracket
18. Roth conversions below IRMAA Brkt 5
19. Roth conversions to fill 35% bracket
20. Maximum Roth conversions

(*The term "Tax-Free" refers to Roth accounts, which may be subject to tax or tax penalties on withdrawals if the owner is below age 59.5 and the account has been open for less than five years, or if funds converted to the account are withdrawn within five years.)

You can change which strategy or strategies you are viewing in the Tax Lab by clicking the Strategy dropdown menus.

All distribution strategies obey rules on when withdrawals can be taken from accounts (e.g., premature withdrawal penalties, restrictions on in-service withdrawals) and required distribution rules (e.g., RMDs). The “Pro-Rata” method takes withdrawals in proportion to account size. The “Tax Ordered” methods (2-7) take withdrawals from accounts of one category and, when that category is exhausted, move on to the next category. The Roth conversion methods (8-14) take planned withdrawals needed for the target income level in “Taxable, Tax-Deferred, Tax-Free” order and then, if any space is remaining in the target Federal income tax bracket, execute Roth conversions in an amount that is estimated to fill that bracket.

Example of Roth Conversions to 12% Brackets

The graph above shows how different types of income in a given year stack up within Federal ordinary and long-term capital gains tax brackets. The 0% bracket contains all non-taxable income as well as income deducted via the standard deduction. If a plan contains plans for Qualified Charitable Distributions (QCDs), qualified withdrawals from Health Savings Accounts (HSAs), qualified withdrawals from 529 education savings accounts, or other items, these will appear as non-taxable income.

Taxes for Roth conversions are assumed to be paid first from any unspent non-portfolio income, then via withdrawals from taxable accounts, and finally via withdrawals from tax-deferred accounts (which results in lower net Roth conversions). This is primarily visible when running a "How can I spend $X, net of tax?" plan.

The Tax Lab allows you to explore a single distribution strategy or to compare any two strategies and even any two plans.

The Tax Lab includes coverage for Federal ordinary and long-term capital gains income taxes, net investment income tax, FICA, state and local income tax, and Medicare IRMAA. Amounts shown in tax estimates for Medicare IRMAA exclude base Medicare premiums, which are paid by all regardless of income level.

All tax statistics are estimates based on plan inputs and should not be relied upon for tax and legal purposes. Please consult a tax advisor before taking tax-related actions.