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A Retirement Tax Strategy
Old 11-10-2014, 08:54 AM   #1
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A Retirement Tax Strategy

I retired from MegaCorp last year at age 57 with a 7-figure 401K, almost all of it Before Tax. Because I separated from service after age 55, I am able to take withdrawals from 401K without paying the 10% penalty for early withdrawals. I am in process of doing some end-of-year tax planning when it struck me that there is a way to withdraw a 'small' amount from my 401K each year until I turn 65 without paying ANY taxes on the withdrawal by 'washing' the withdrawal through my HSA.
I can contribute the maximum $7550 to my HSA this year. I would withdraw that amount (+20% to cover the automatic FWT, or ~$9437 total) from 401K, deposit the net $7550 to my HSA, then withdraw $7550 tax free from my HSA which would 'remimburse' me for a part of my medical insurance premiums for this year. The $ withheld for FWT from the 401K withdrawal would be refunded to me when I file my taxes for this year (actually, it would reduce my taxes due by that amount so I don't even have to wait for the refund. I get an immediate benefit).
Has anyone tried this strategy? Any 'gotchas' I missed?
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Old 11-10-2014, 09:06 AM   #2
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Has anyone tried this strategy? Any 'gotchas' I missed?
Do you have other income or not? Assuming you do, if you didn't withdraw from 401k but contributed to HSA the same way, you would get a tax deduction, which reduces your taxes. Now when you withdraw from 401k, it "washes" away that deduction. In effect you are still paying taxes on your withdrawal.

Therefore, contribute to HSA regardless whether you withdraw from 401k or not. If you don't need the money from the 401k, rollover a small amount to Roth IRA every year.
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Old 11-10-2014, 09:10 AM   #3
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If I recall correctly, we can't use HSA funds to pay medical premiums until we hit Medicare.
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Old 11-10-2014, 09:15 AM   #4
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If I recall correctly, we can't use HSA funds to pay medical premiums until we hit Medicare.
you are correct........there may a few more fine exceptions but normal health insurance premiums are not qualified HSA expenses.
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Old 11-10-2014, 09:46 AM   #5
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Do you have other income or not? Assuming you do, if you didn't withdraw from 401k but contributed to HSA the same way, you would get a tax deduction, which reduces your taxes. Now when you withdraw from 401k, it "washes" away that deduction. In effect you are still paying taxes on your withdrawal.

Therefore, contribute to HSA regardless whether you withdraw from 401k or not. If you don't need the money from the 401k, rollover a small amount to Roth IRA every year.
I have other income streams, and a large after-tax account. Usually, I contribute the max to the HSA each year from the after-tax account. This strategy struck me as a tax free way to fund the HSA from the 401K instead (almost like a rollover to a Roth, but unlike a Roth rollover I wouldn't be paying any taxes on the conversion and won't be subject to complications from the Roth 5-year rules).

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If I recall correctly, we can't use HSA funds to pay medical premiums until we hit Medicare.
I missed that 'little' detail.
No big deal. I actually haven't made any withdrawals from my HSA. My plan is to let it accumulate as an insurance for a year when I might have some abnormally high medical expenses. And then use what is left to pay for Medicare premiums when I do reach 65.
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Old 11-10-2014, 01:29 PM   #6
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Assuming you had the funds, wouldn't it be better to use your taxable account to fund the HSA. Then you wouldn't necessarily pay a tax on the funds withdrawn and you would get a tax deduction for the HSA. I assume you would still have a HDHP after you retired?
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Old 11-10-2014, 02:47 PM   #7
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Might just want to take the HSA deduction from your other income and let the 401k ride. The HSA deduction is nice, but withdrawing from your 401k before you need to isn't great. If the HSA deduction drops you into a lower tax bracket, you might want to fill it in with the 401k withdrawal.

You would be paying taxes on that +20% extra you're taking from the 401k for taxes. So it's not a total wash.
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Old 11-10-2014, 04:50 PM   #8
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I am similar to you in that I have a lot of taxable and tax-deferred funds. What I have done the last few years fully fund my HSA from after-tax funds and do Roth conversions to the top of the 15% tax bracket to try to reduce my tax-deferred accounts as much as possible before RMDs start once I turn 70.

I have a file of all my qualified medical expenses since my HSA began and can withdraw that amount tax and penalty free anytime I need to.

Have you done a pro forma 2014 tax return yet so you can see how your strategies will play out. Don't forget state taxes too. In my first year of ER my state tax bill exceeded my federal tax bill - unpleasant surprise.
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Old 11-10-2014, 09:19 PM   #9
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This years expenses are being extracted from taxable account.

Only income for the year is small 6k profit sharing check, which will fit in tIRA, there will be no tax due.
Remove funds from tIRA, deposit in HSA, there will be no tax due, Schwab ask if I want to withhold tax, no thanks.
55k converted to Roth so far, still zeroing in on the 15% limit with deductions, no tax withheld as I already had the 9% covered.
My first year, hope I'm doing it right.
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