401K withdrawls - taxes

[getoutearly]

I just recently woke up and came to the realization that after retirement, when withdrawing funds from investment accounts, not the whole withdrawl is taxable, but it is dependent on what is being withdrawn, and the cost basis for it. And then, it is probably not taxable as income, but as capital gains (or, maybe a little of both?).

My question is, how does that apply to withdrawls from 401K's? Is every dollar withdrawn from a 401k taxable as income (withdrawls either thru the 72-T(?) equal and substantial (or whatever the term is) before 59-1/2, or withdrawls after 59-1/2)? Or, do/can you calculate the cost basis and only pay cap gains on the gains? Not sure how much detailed info is kept on the 401k's.

May be an obvious answer, but I always just assumed that when I retired, every dollar I spent from my investment accounts would be treated as income and taxed as such. Pretty stupid I know; the good thing is, my retirtement-needs calculations were, by definition, more conservative than I thought (and I was already trying to be quite conservative).

Surely, the 401k holders are required to keep track of the amount we put in, versus the amount it is worth now; and the gain?

What am I missing?

 

[TromboneAl]

With my trad IRA and SEP-IRA every dollar I take out will be taxed as income.  I didn't pay tax when I put it in, that's why. I don't need to keep track of contributions vs. gains.

 

[rmark]

I think 401k and 403b are all taxed as income.

 

[cute fuzzy bunny]

Basis for 401k is usually only a factor when withdrawing early.

When withdrawing normally at the proper age (what is it? 59.5?) its taxed as ordinary income just like you earned it.

What i'm not sure of is if it COUNTS are earned income...that'd be pretty cool, being able to fund a Roth with IRA/401k withdrawals...

 

[Martha]

Basis for 401k is usually only a factor when withdrawing early.

When withdrawing normally at the proper age (what is it? 59.5?) its taxed as ordinary income just like you earned it.

What i'm not sure of is if it COUNTS are earned income...that'd be pretty cool, being able to fund a Roth with IRA/401k withdrawals...

Basis is not relevant when withdrawing early. No matter what, it is ordinary income. (Well almost no matter what, there are some odd rules for stock in your own company and I am assuming you contributed pretax dollars) Early withdrawls mean there is a penalty as well.

It isn't earned income. Would be nice though.

 

[cute fuzzy bunny]

Crap.

I wonder why turbotax tracks IRA/401k basis...

Maybe i'm thinking of something else. Maybe I need another donut and another cup of coffee.

 

[Nords]

I wonder why turbotax tracks IRA/401k basis...

Conversions.

It was a lot easier in the good old days (before 1986) when just about everyone could take a deduction for a conventional IRA contribution.

Maybe i'm thinking of something else.  Maybe I need another donut and another cup of coffee.

TH ol' buddy, looking at your posting record thus far this morning, I'd say that the LAST thing your brain needs is more sugar & another cuppa caffeine!

 

[REWahoo]

TH ol' buddy, looking at your posting record thus far this morning, I'd say that the LAST thing your brain needs is more sugar & another cuppa caffeine!

Don't be shy TH. If you've got some thing to say, just say it!!!

 

[cute fuzzy bunny]

Shhhh...if he notices we're going to end up seeing those six self-replies to his own off topic self aggrandization in every thread again...

Isnt it time to get rid of those post counts?

 

[TromboneAl]

that'd be pretty cool, being able to fund a Roth with IRA/401k withdrawals...

You can do that -- Just do a Roth conversion:

"...you can convert your traditional IRA into a Roth if you are willing to pay the up-front tax hit. There is no earned income requirement for conversions. " (from SmartMoney.com).

One tentative plan I have is for my early years when I am using money from taxable accounts, and will be paying almost no taxes, I will convert some Trad IRA money to Roth each year.

 

[New Thinking]

There are some employer plans that that look like regular 401(k)s to the individual employee yet contain both an option for pre-tax and post-tax savings..The pre-tax savings which most of the poster allude to, are taxable as ordinary income when you decide to take the income out of the plan directly or from an IRA (which you rolled over to)..However, if you contributed on an after-tax basis, the cost-basis (what you put in) would indeed be received tax-free..Not many of these plans exist anymore, but some do..In the future, they should be replaced mainly by Roth 401(k)s..Why pay any tax at all with after-tax contributions..The only reason is that you may want to get at your money prior to retirement.

 

[dory36]

There is a very interesting calculator at http://www.i-orp.com that lets you optimize your retirement withdrawals for minimizing taxes.

From their description:

To run ORP you provide your tax-deferred and after-tax savings, your age, your spouse's age, and your planned annual savings until retirement. ORP will compute your cash flow during retirement from investment returns and drawing down your capital to a given estate level at the end of the plan. ORP's embedded linear programming optimizer maximizes the cash available, during retirement, based on inflation and compounding investment returns while meeting Internal Revenue Service requirements.

 

[LOL!]

There are some employer plans that that look like regular 401(k)s to the individual employee yet contain both an option for pre-tax and post-tax savings....

If you add any money that was already taxed to a retirement plan, then you and the IRS keep track of it.   For example, if you have contributed to a non-deductible traditional IRA, then you will be submitting a Form 8606 with your Form 1040.  Thus you inform the IRS of your post-tax contributions.  I think the same thing goes for after-tax contributions to a 401(k).

When you begin withdrawals, you don't get to withdraw the after-tax contribution first, but instead your withdrawals are calcualted to be pro-rata portions of after-tax contributions and pre-tax contributions.  This can all be figured out with a handy IRS worksheet.

But hopefully, you do not have after-tax contributions to IRAs and retirement plans or variable annuities.  Why pay a higher tax rate than the low capital gains tax rate afforded to after-tax gains? Why set yourself up for the possibility of an early withdrawal penalty when you don't have to?

 

[Nords]

But hopefully, you do not have after-tax contributions to IRAs and retirement plans or variable annuities.  Why pay a higher tax rate than the low capital gains tax rate afforded to after-tax gains?  Why set yourself up for the possibility of an early withdrawal penalty when you don't have to?

Sure, in a perfect world!

We made a couple years' deductible contributions to conventional IRAs but the 1986 tax reform stopped that in its tracks.

We started making non-deductible contributions to the IRAs (as well as starting Roth IRAs) where at least the gains are tax-deferred.

I think that tax-deferred compounding, paying conversion taxes at up to the 15% rate with outside funds, and ending up with a tax-free Roth beats paying annual cap gains taxes.

We didn't worry about early withdrawal penalties because they could be avoided via 72(t) or altogether from the Roths.

 

[LOL!]

I think that tax-deferred compounding, paying conversion taxes at up to the 15% rate with outside funds, and ending up with a tax-free Roth beats paying annual cap gains taxes.

Why would you be paying annual cap gains taxes?  Oh, I get it, you are trading in this account and not just buying some ETF or index fund that rarely has a cap gain distribution.

But your point is well-taken: maybe at some point in your life you can convert an IRA to a Roth if you are in a low enough tax bracket that it makes sense. OTOH, if you are in that low a tax bracket, your cap gains tax rate would be 5% or 0%.

 

[Nords]

But your point is well-taken: maybe at some point in your life you can convert an IRA to a Roth if you are in a low enough tax bracket that it makes sense.  OTOH, if you are in that low a tax bracket, your cap gains tax rate would be 5% or 0%.

Yep, that certainly depends on tax efficiency.

We can also look ahead to our 60s and see that spouse's pension will put us in a higher tax bracket than today. Then in our 70s we'll be taking RMDs and paying tax on SS.

There are probably a half-dozen different factors affecting Roth IRA conversions. The calculators tend to focus on just the differences between conventional & Roth IRAs while overlooking the effect of SS, paying taxes outside the conversion, and periods of low income before RMDs. At least Fairmark's conversion calculator looks at the tax issue.

 

[TromboneAl]

Right, that's my reasoning. Let's say that early in retirement I have no income, and use after-tax accounts for living expenses. If I convert $10,000 to a Roth, I will pay little or no taxes on it.

If I left it in the trad IRA and took it out when I was 63, I might have an income of $50,000 including the other IRA money I withdraw and SS. So then, I'd be paying more tax on it.

 

[whitestick]

Slightly different question - is there an upper income limit on being able to convert IRAs into ROTHS, like there is for adding to ROTHS. Does the catch up provision apply to the amount of conversion funds, like contribution funds. My ROTHS are too low, and my straight IRAs have some room in them. Especially via using the taxable funds to pay the 15% convversion costs.

 

[gindie]

Whitestick,
Yes, the AGI limit is $100,000 in the year of the conversion (not including the amount of the IRA you are converting). This limit is for singles, marrieds, and HOH. If married, you must file a joint return.

 

[cute fuzzy bunny]

I'm thinking if your income is too high to do a conversion, you're probably going to pay too much to convert the funds.

Its not a fixed 15%; the 15% discussion relates to people converting to fill their income level until they exceed the federal 15% tax rate. In essence, the IRA was pretax money...to convert it the IRS looks at is as though you are now receiving that money as income, its taxed, then reinvested as a roth. You'd then have to have higher returns on the Roth to the point where they would exceed the original IRA, its returns, minus the deferred tax hit.

 

[Martha]

For 2006, the married filing jointly 15% tax bracket tops out at $61,300. With a standard deduction of $10,000 plus personal exemptions for $3200 each, the 15% bracket is pretty generous. But as CFB says, you have to keep all of your taxable income within that bracket, including the IRA amount you are converting, or you will jump into the 25% bracket. So if you are at $100,000 income, even though you are eligible to convert, you might not want to because of the tax hit.

 

[cute fuzzy bunny]

Wow that is a generous number.

In my case, our tax level is so low a conversion wouldnt make sense at all. I've run the calculators and we'd actualy come up with about 25k less if we converted and paid taxes now on the conversion, earned the same rate, and started withdrawal at the same time, and took all of the money.

Plus I *know* the little SOB's will put in a flat tax or national sales tax a month before I start withdrawals