25 Replies Latest reply on May 2, 2014 2:23 PM by BoBraxton

    Paying the least amount of taxes on 401K withdrawals

    cyber888
      Ok so how do you avoid paying taxes for 401K withdrawals?
      Could a good schedule of yearly withdrawal plans from your 401K do the trick ?

      So let's say you have a good amount of savings in CDs or after-tax IRAs, would it  be best to combine that with smaller withdrawals from your 401K .. and make it last a long while.
       
      Withdrawing money from you 401K is considered as income but withdrawing money from your after-tax savings is not.
       
      In 2013, I think if your income (as a couple is less) than 17,800, the IRS says you pay no federal income tax.   You might pay a little for state taxes.  But am I correct to say that if you withdraw less than 17,800 from your 401K and that's your only "income" as a couple, you'd be paying zero federal taxes, correct?   
        • Re: Paying the least amount of taxes on 401K withdrawals
          JerryD
          At a certain age, 70 1/2 for an IRA and probably the same for a 401k, the IRS determines how much you MUST withdraw depending on your age (really on your life expectancy as determined by IRS rules). If you don't, the penalties on the under-withdrawal are very steep. Make sure that you understand these rules. I plan to let TIAA-CREF determine how much needs to be withdrawn.
           
          The amount upon with the withdrawal is determined should be the value of the account on 12/31 of the previous year.
            • Re: Paying the least amount of taxes on 401K withdrawals
              cyber888
              Yes, I am aware about the mandatory distribution at 70 1/2. 
              That's why I'm planning to retire early and start withdrawing before I hit 60, so I will never be taxed :)  That's the whole point of this discussion.  
               
              See if you wait till 70.5 and withdraw a big amount due to mandatory distribution, your tax will be sky-high high.   Better start withdrawing enough at 58 or 60 not to pay taxes, so when you hit 70 you don't have too much in your 401K that you'll be hit by higher taxes for not withdrawing early on.
               
               
                • Re: Paying the least amount of taxes on 401K withdrawals
                  Sharon
                  Unless you have a ROTH IRA, you will be hit with taxes on whatever you take out since you never paid tax on the money in the first place.  That may really HURT.
                  Your idea of taking it out now...makes sense.  Pay the tax, put it in something that grows and pay tax as you go.  Then it doesn't hurt all at once.  Especially with inflation, the $ your worked hard to put away has little value in the future so you need MORE than you thought.
                    • Re: Paying the least amount of taxes on 401K withdrawals
                      JerryD
                      I agree that a Roth is a good idea to avoid taxes on sheltered retirement assets. We even pay out of taxable funds every year to convert more of our IRA's to Roth's to avoid higher taxes when mandatory required distributions start.We intend to use the Roth's as an emergency fund or as an estate should we never use them.
                       
                      However, I don't necessarily agree with taking out IRA funds to avoid future taxes. It all depends on what your tax rate will be in retirement. One can stay at a 15% marginal tax rate for a considerable income after standard deductions. Depending on how much you have and how well you invest, keeping assets in sheltered accounts can build future withdrawals at a faster rate than distributions and taxes can deplete. Make sure you understand the math before running down these sheltered opportunities.
                        • Re: Paying the least amount of taxes on 401K withdrawals
                          Sharon
                          Not sure I understand what you said, but since we are having to use my TIAA CREFF money long before we planned to, it was a big shock to have to pay 20% on the money.  
                          We have not had to pay any income tax for the past few years as we have been living on savings and the limited interest the savings earned.  We both get Social Security but collected in our early 60's when we'd planned to wait till we were 70.
                          Having lost our jobs & businesses when we were barely 60 and not able to find other work (as someone mentioned people don't hire old folks) we have been living on savings.
                          We may have to sell our house one day as it is worth A LOT OF MONEY, but to downsize we'd have to leave the "clean air" and don't want to. Don't mean to complain, we are doing fine...just planed for things to be better.

                          So no matter what you plan, expect the worst! 
                            • Re: Paying the least amount of taxes on 401K withdrawals
                              smaneck
                              Did you take your money out of an IRA or a 401K or 403B? Because if you roll it over into an IRA before taking it out, they don't withhold 20%. Of course you have to pay tax on it eventually. 
                                • Re: Paying the least amount of taxes on 401K withdrawals
                                  Sharon
                                  Thanks. A 403B
                                  Seems pointless to transfer $ from 403B to an IRA if you are going to take it out within a year. Still have to pay taxes since money put in that was never taxed.
                                  I still like the ROTH idea where you pay taxes on earned money WHEN you earn it, not when you take it out.
                                  Think of the past...50 years ago an income of $10,000 a year was a good income.  If you saved from that and gradually increased your earnings, etc. when you finally need the money in this day and age, that $10,000 a year is now needing to be $100,000 a year.
                                  Not many people save that much even a good % of interest and then have to pay tax all at once.
                                  Peace of mind is what I need as I get older.
                                    • Re: Paying the least amount of taxes on 401K withdrawals
                                      smaneck
                                      Certainly if you are going to take the whole 403b within a year. But generally speaking IRAs have more flexibility. Roth IRAs are ideal the younger you are if you are still in a fairly low tax bracket. But if you are in a lower tax bracket when you retire then traditional IRAs might make more sense. I have money in both and figure the traditional IRA will fund my minimum living expenses and the Roth will be used for the unexpected ones.  
                                        • Re: Paying the least amount of taxes on 401K withdrawals
                                          Sharon
                                          Sounds like you planned well for your retirement.
                                            • Re: Paying the least amount of taxes on 401K withdrawals
                                              JerryD
                                              Sharon said...
                                              ...
                                              Having lost our jobs & businesses when we were barely 60 and not able to find other work (as someone mentioned people don\'t hire old folks) we have been living on savings.
                                              We may have to sell our house one day as it is worth A LOT OF MONEY, but to downsize we\'d have to leave the \"clean air\" and don\'t want to. Don\'t mean to complain, we are doing fine...just planed for things to be better.
                                              ...
                                              Had a similar scenario. Lost long-term job after close to 15 years there and at 49. Spent lots of time looking for jobs. Made some good money interrupted by layoffs. Lived on savings. Worked some government temp jobs. Looked into temp teaching but didn't crack that one. These jobs are around if you can find a connection.
                                              With all jobs I maxed out the retirement savings and placed them in conservative, non-principal losing investments so they could be counted on for retirement. For short jobs dumped all of the income into Roth's equally for both of us while living off savings to get sheltered status on income.
                                              One thing it took me a while to figure out is that everybody is entitled to standard deductions, exemptions, itemized deductions (interest, state/local taxes, medical, etc.). If you can't use all of these tax relief mechanisms to offset income, use them to convert any IRA's to Roth's basically tax-free up to the deductions that you are entitled.
                                          • Re: Paying the least amount of taxes on 401K withdrawals
                                            BoBraxton

                                            "Metro" has signs (on the bus, exterior) saying "safety is our top priority."

                                            However, I would think that for an organization that provides transportation,

                                            "transportation" (services) should be their actual top priority. Because otherwise

                                            they could just leave all the busses in the garage and never run them,

                                            which would be pretty safe, I believe.

                                            Spouse and I both had 403(b) but different (less trying) circumstances.

                                            In part it would depend on the mix of investments in the 403(b).

                                            For ours, there were quite a lot in the mixture.

                                            Not only did we roll over into a "traditional" Roll-over IRA but we also put into one company,

                                            one broad-based fund. These actions for us over the passage of the most recent twelve months

                                            was worth about one fifth of a million dollars. Of course we could have Lost that much (and more) as well

                                            but that is not the way the football bounced this time.

                                  • Re: Paying the least amount of taxes on 401K withdrawals
                                    CurtGufe
                                    cyber888 said...
                                    Ok so how do you avoid paying taxes for 401K withdrawals?
                                    Could a good schedule of yearly withdrawal plans from your 401K do the trick ?

                                    So let\'s say you have a good amount of savings in CDs or after-tax IRAs, would it  be best to combine that with smaller withdrawals from your 401K .. and make it last a long while.
                                     
                                    It's complicated but minimizing taxes on withdrawals from a 401k (any qualified plan) means retiring before one starts collecting social security and using that time in early retirement to convert the 401k funds into Roth IRAs. This requires a sizable after-tax fund and/or defined-benefit pension income to used before taking social security. Doing a plan like this is especially needed if one expects a large amount of SS (over 60K for the household with delayed credits) and if one has a large amount in tax-deferred accounts (401k/403b/traditional IRAs.)
                                     
                                    I plan to retire in a couple of years at age 60 and then spend the next 10 years living off after-tax savings and my wife's modest military reservist pension while converting my entire tax-deferred accounts into a Roth IRA. At 70, we will start converting/withdrawing my wife's smaller amount in tax-deferred accounts at a slow rate over 15 years. To minimize taxes, it helps to keep (after starting retirement) all the fixed-income assets in tax-deferred accounts and growth equity assets in Roth IRA accounts and dividend-paying equities assets in the after-tax accounts. This slows the growth of the tax deferred assets and minimizes taxes on after-tax income. If all goes well, I'll have spent the after-tax assets by age 70 and then will live off SS, the military pension, and the modest withdrawals from my wife's tax deferred accounts without having to take anything out of the Roth IRAs until 25 years after retiring. However, our Roth IRAs may be needed earlier than that if SS is not fixed by Congress prior to it running out of reserves.
                                     
                                    It is important to remember that for households that get sizable social security income, the marginal US tax rate on every dollar of other income when taking SS is 1.5 or 1.85 times your marginal US tax rate due to the "other" income (401k conversions or withdrawals, but not Roth IRA withdrawals) impacting taxation of SS income. This applies in our case because half our combined SS plus the military pension will be greater than $44K, a threshold that is not indexed for inflation. If one is in the 15% tax bracket, this translates to a 27.75% tax rate on additional income.
                                     
                                    Most of my tax-deferred contributions were saved against a marginal rate (state+US) of 29.25% or more. So at least the money is coming out of the tax deferred accounts at a lower marginal tax rate than when it was going into those accounts. The trick is to keep the Roth conversions low enough to stay in and under the 25% US tax bracket and do these conversions before SS starts to avoid the impact on SS taxation.
                                     
                                    Doing this will require a somewhat complex sequence of financial states that last 25 years (I left out a few details from my story that further complicate matters). I hope that I remain lucid enough long enough to pull it off. However, I don't think a system that is this complicated is the right thing for most people. By that I mean that tax planning for retirement is entirely too onerous. Congress should work to simplify taxation on seniors.
                                      • Re: Paying the least amount of taxes on 401K withdrawals
                                        BoBraxton

                                        @CurttheScientist I am glad you remain lucid thus far. It is a supreme irony (in my view) that as the potential for mental decline increases, things are a lot more complicated, at least in our experience. This is a good topic for me to jump into because less that three years of retirement (in total) figuring out the income(s) - they are many - for retirement is by far the most involved. Up until now, I have felt like I got no assistance (or little). As far as I can tell, there is no "one fits all" formula and individuals / couples are pretty much left on our own to "sink or swim" in the deep end. Depends. (and I'm not talking garments).

                                      • Re: Paying the least amount of taxes on 401K withdrawals
                                        I don't know if this applies to your situation, but last year we had a rebalancing analysis done by TIAA-CREF; during the rebalancing the analyst from TIAA said TIAA would help decide how much and when we should take money out of our 403(b) when that time comes, to cut down on our taxes (tax advantaged withdrawals, is that what he called it?). Maybe TIAA can help you plan those withdrawals if that's your goal.
                                         
                                        It also occurred to me that you should be careful about what you do with the money once you start withdrawing it before the mandatory date. If you started withdrawing it at age 60, and started spending it rather than investing it, you lose out of all that investment equity growth from age 60 to age 70. Sure, your tax bill will be higher at age 70, but your account will have grown much larger in those 10 years than if you had spent the money right away.
                                    • Re: Paying the least amount of taxes on 401K withdrawals
                                      cbslc
                                      My plan was to retire around 45 and start slowly rolling over  403b and 457s to Roths. Do you think that will work?
                                        • Re: Paying the least amount of taxes on 401K withdrawals
                                          JerryD
                                          You are indeed fortunate or maybe just toying with us. Don't know any people personally that can play their retirement funds through retirement starting at 45 unless you are fortunate enough to live where you can live off of road kill (and can stomach it), are healthy (until you're not), walk or ride a cheap bike everywhere and have a paid off shelter with little or no taxes and plenty of wood to burn.  Oh, forgot! Or won the lottery or had a rich uncle that died recently.
                                          • Re: Paying the least amount of taxes on 401K withdrawals
                                            smaneck
                                            cbslc said...
                                            My plan was to retire around 45 and start slowly rolling over  403b and 457s to Roths. Do you think that will work?
                                             
                                            You realize that you can only withdraw the principle from that IRA before you are 59 1/2?
                                             
                                            You'd have to be might wealthy to retire at 45. I think most of us don't get all that serious about saving for retirement until we reach that age.   
                                              • Re: Paying the least amount of taxes on 401K withdrawals
                                                cbslc

                                                The 59.5 thing is a problem for the 403b, and Roth IRA. But we maxed out annual contributions to our 457's. The 457's allow access to the money after 6 months of separation from employer. So the plan is to live off cash, roth principal (but this will be the last resort), 457 and a lifetime annuity (500/mo compounding 2.5%/annum). From 45 - 59.5, I plan on converting some of the 403b to Roth - being careful to keep us in same tax bracket ... So we can hopefully reduce RMD's. and at 59.5 start spending down the 403B. Then after 70.5 RMD's, Roth's, and annuity should keep us afloat. I still have fears about the lifetime annuity - it pays the max of 30 years or my wife's lifetime. But that is assuming Aviva insurance is still around!

                                                We've been tracking our expenses very diligently for the past 5 years and typically spend 12-15k/year (depending on where we vacation or fix around the house). Again we own our house, have health insurance from my work,  have no kids and live cheap. When people talk about spending less in retirement, I think no way. Our expenses will be at least 200% of what we spent pre-retirement.

                                                  • Re: Paying the least amount of taxes on 401K withdrawals
                                                    BoBraxton

                                                    "no way" was also my personal response -- what kind of retirement would it be to refrain from spending after all the decades of skimping and scraping -- better to stay employed (paid of course) and not retire otherwise. I agree that in retirement the spending is likely to be (much) greater. We are less than three full years into ours. For one thing, my spouse wants to do all kinds of "projects" she has put off (patiently) for the most recent three decades since the purchase of our house.