Factoring 401k plans in FIRE calculations

[obgyn65]

Hello everyone

Just wanted to ask how people have been factoring their 401k plans in their calculations. How did you calculate the impact of taxes for example ? How did you calculate the increase in value in your 401(k) between this year and when you plan to use your plan (in my case, at age 60) ?

This is the Excel formula I use in the row corresponding to year 2025, when I turn 60:

+(178000*1.015^13*0.78)*0.05*0.78

Explanation of the formula:

$178,000 = present value of my 401(k) plan (I have worked less than 10 years in the US and I only use the most conservative investments, hence the low balance)

* 1.015^13 = the performance of my 401(k) plan over the next 13 years (I will continue being conservative)

* 0.78 = taxes when I take all the money out of my 401(k) plan

*.05*0.78 = if I decide to buy an SPIA with this money at age 60, I may get a 5% annual rate, which I guess will be taxed again as income...

Result : $6,571 per annum

Any flaw with this approach ? (I am sure there is )

Looking forward to comments. Thank you.

 

[LOL!]

I don't intend to pay any taxes on my 401(k) withdrawals in retirement. I've used www.i-orp.com and TurboTax that confirm that I will not need to pay any taxes on those withdrawals.

 

[pb4uski]

The smart play would be to convert the 401k to an IRA and have the IRA buy the SPIA so while there would be no upfront tax if done correctly, the SPIA payments would be taxable income. However, a 22% tax rate in retirement seems high to me. Would be a nice problem to have I guess.

5% payout rate seems too low. Have you check out immediateannuities.com?

 

[Animorph]

Very heavy on taxes. Only some of the SPIA payments should be taxable if you've paid for it with taxed money.

 

[obgyn65]

Thank you, I will have a look at i-orp.

I don't intend to pay any taxes on my 401(k) withdrawals in retirement. I've used www.i-orp.com and TurboTax that confirm that I will not need to pay any taxes on those withdrawals.

 

[obgyn65]

Hello pb4uski - do you have a reliable internet reference about the exact process to follow to convert the 401k to IRA and have the IRA buy the SPIA to minimize taxes ? Thank you.

Yes I did check immediateannuities and I assume the rates are going to continue to fall in the next 13 years.

The smart play would be to convert the 401k to an IRA and have the IRA buy the SPIA so while there would be no upfront tax if done correctly, the SPIA payments would be taxable income. However, a 22% tax rate in retirement seems high to me. Would be a nice problem to have I guess.

5% payout rate seems too low. Have you check out immediateannuities.com?

 

[obgyn65]

Animorph - it seems you are correct. I just found this website :
https://personal.vanguard.com/us/whatweoffer/annuities/income-comparison
Quote : "withdrawals and payments from annuities are taxed differently based on the type of assets used to purchase the annuity (qualified versus nonqualified)."

I would like to know how this works out concretely but could not find more details. Do you know ?

Very heavy on taxes. Only some of the SPIA payments should be taxable if you've paid for it with taxed money.

 

[obgyn65]

Actually I was just looking at this page : 401(k) IRA matrix - Wikipedia, the free encyclopedia
and it seems that all the distributions from traditional IRAs are taxed as ordinary income (except any non-deducted principal). What is non deducted principal ?

This is confusing to me.

 

[MichaelB]

Actually I was just looking at this page : 401(k) IRA matrix - Wikipedia, the free encyclopedia
and it seems that all the distributions from traditional IRAs are taxed as ordinary income (except any non-deducted principal). What is non deducted principal ?

This is confusing to me.

Oby, if the deposits made into the 401k were With pretax income, 100% of withdrawals will be taxed. If some of the contributions were after tax, that is called non-deductable and that amount would not be taxed again when withdrawn.

+1 @ pb4uski's suggestion to convert the 401k to an IRA and then annuitize.

 

[kaneohe]

Oby, if the deposits made into the 401k were With pretax income, 100% of withdrawals will be taxed. If some of the contributions were after tax, that is called non-deductable and that amount would not be taxed again when withdrawn.

+1 @ pb4uski's suggestion to convert the 401k to an IRA and then annuitize.

I agree that OP has 1 too many 0.78 in Excel (double-taxing). If OP did have after-tax contributions in 401K (less common), wouldn't OP want to peel those off and put in Roth so earnings would grow tax free........I'm assuming that can be done? The pre-tax contributions could go into TIRA for tax-deferral.

 

[Bimmerbill]

Don't forget to add the yearly contributions to your 401K if you plan to make any while you still can.

 

[Tree-dweller]

Isn't keeping the 401k post-retirement an option?

Newly-retired as of last December, and I frankly have been taking the lazy-man's approach to 401k distributions. There seems to be a consensus in this thread so far that moving 401k funds to another instrument is the way to go. But I have been keeping the 401k money in the 401k so far, and it's been good to me. Decent (5+%) returns on a moderate/conservative AA, fees of .05%. I have the luxury of a decent pension and still-employed DW. Again, this is admittedly a default approach that works for me, but I am interested in hearing why it may/should be improved. Thanks!

 

[kaneohe]

Newly-retired as of last December, and I frankly have been taking the lazy-man's approach to 401k distributions. There seems to be a consensus in this thread so far that moving 401k funds to another instrument is the way to go. But I have been keeping the 401k money in the 401k so far, and it's been good to me. Decent (5+%) returns on a moderate/conservative AA, fees of .05%. I have the luxury of a decent pension and still-employed DW. Again, this is admittedly a default approach that works for me, but I am interested in hearing why it may/should be improved. Thanks!

Some of the usual reasons stated are for greater selection of investments, lower costs, more flexibility of withdrawals. You may already have "sufficient" selection of investments and low fees, and it sounds like you may not need withdrawals........at least for now.........so probably no need to rush to do that move now (or possibly ever). Some 401K plans are not very flexible with respect to withdrawals.....mine is basically withdraw all or nothing...........but if you can hang on till age 70.5, you get the RMDs then.

One advantage of keeping in 401K is creditor protection which is battleship-strength for 401K and, depending on state, may be same or considerably weaker for an IRA.
************************************************************
Asset protection - Bogleheads

Investing in a 401K

The Employee Retirement Income Security Act (ERISA) provides 401Ks and other ERISA-governed retirement plans with rock-solid protection from creditor judgments. [12] This protection applies to judgments other than bankruptcy, and it applies in all 50 U.S. states.
Individual Retirement Accounts (IRAs) don't receive those federal protections, although some states shield IRA assets from creditor judgments.
The language of the federal law governing rollover of assets from a 401K plan to an IRA is ambiguous. That law, the Bankruptcy Abuse Prevention and Consumer Protection Act, states that $1 million in IRA assets is protected in bankruptcy without regard to amounts attributable to rollover contributions.
According to the Wall Street Journal, "most experts say that phrase should be interpreted to mean that amounts rolled over from employer plans get creditor protection, as well. But others ... believe it means that the $1 million is determined 'without regard' to whether the amounts are attributable to rollovers."[13]
In short, maximizing contributions to a 401K plan is an excellent asset protection strategy; investors considering rolling over assets from a 401K plan to an IRA should carefully consider the asset protection implications.

 

[Tree-dweller]

Some of the usual reasons stated are for greater selection of investments, lower costs, more flexibility of withdrawals. You may already have "sufficient" selection of investments and low fees, and it sounds like you may not need withdrawals........at least for now.........so probably no need to rush to do that move now (or possibly ever). Some 401K plans are not very flexible with respect to withdrawals.....mine is basically withdraw all or nothing...........but if you can hang on till age 70.5, you get the RMDs then.

Thanks for that. Any my apologies to the OP, I don't want to hijack your post.

 

[Katsmeow]

Newly-retired as of last December, and I frankly have been taking the lazy-man's approach to 401k distributions. There seems to be a consensus in this thread so far that moving 401k funds to another instrument is the way to go. But I have been keeping the 401k money in the 401k so far, and it's been good to me. Decent (5+%) returns on a moderate/conservative AA, fees of .05%. I have the luxury of a decent pension and still-employed DW. Again, this is admittedly a default approach that works for me, but I am interested in hearing why it may/should be improved. Thanks!

DH retired a couple of years ago and initially left some money in his 401k but the options for withdrawal were very limited. Also, the options for investment were not horrible but very limited.

And, the big thing is that you say you have fees of .05%. (I assume you really mean .50% as fees of .05% would be unusually low). If all fees really are .05% then that is fine. But assuming it is really.50% (one-half of one percent) then you can do much better at Vanguard.

 

[ziggy29]

And, the big thing is that you say you have fees of .05%. (I assume you really mean .50% as fees of .05% would be unusually low). If all fees really are .05% then that is fine. But assuming it is really.50% (one-half of one percent) then you can do much better at Vanguard.

I can't imagine anyone paying only .05% in a 401K type account unless they are federal employees in TSP.

 

[pb4uski]

Hello pb4uski - do you have a reliable internet reference about the exact process to follow to convert the 401k to IRA and have the IRA buy the SPIA to minimize taxes ? Thank you.

Yes I did check immediateannuities and I assume the rates are going to continue to fall in the next 13 years.

https://personal.vanguard.com/us/whatweoffer/rollover/overview?Link=facet

I think payout rates will increase for two reasons. One, interest rates will increase. Two, you will be older so the payout period will be shorter.

 

[Southern Geek]

I can't imagine anyone paying only .05% in a 401K type account unless they are federal employees in TSP.

I work for a large megacorp. Just yesterday, it released its USG mandated disclosure on 401K fees. I was pleasantly surprised to discover that the Total Annual Operating Expenses for the index funds ranged from 0.06% to 0.09%. These are lower than the fees for the index funds in my Vanguard account. Most managed fund fees were in range of .4% - .5%.OTOH, the fees for the funds my daughters 401(a) provide via County government were ridiculous. Fees on top of fees. A simple SP500 index fund was .22% + .5% admin. Most fund fees were 1.0% or higher.

 

[obgyn65]

Hello Michael. I guess the confusion comes from the fact that 1) I did not mention that my 401(k) is a traditional one 2) pb4uski above wrote "The smart play would be to convert the 401k to an IRA and have the IRA buy the SPIA so while there would be no upfront tax if done correctly, the SPIA payments would be taxable income."

My 401(k) plan is a traditional 401(k) = taxes on contributions have been not paid yet. Therefore my question is : if my withdrawals are taxed when I reach 60, how can I avoid these taxes by converting my 401k to an IRA and then have the IRA buy the SPIA ?

Still not clear to me, sorry.

Oby, if the deposits made into the 401k were With pretax income, 100% of withdrawals will be taxed. If some of the contributions were after tax, that is called non-deductable and that amount would not be taxed again when withdrawn.

+1 @ pb4uski's suggestion to convert the 401k to an IRA and then annuitize.

 

[obgyn65]

No pb, I do it sometimes also.

Thanks for that. Any my apologies to the OP, I don't want to hijack your post.

 

[pb4uski]

There are no tax implications when you rollover your 401k to an IRA (as long as you do a direct rollover where the money goes directly from your 401k provider to your IRA provider). Similarly, there would be no tax implications if your IRA buys a SPIA.

SPIA payments you receive would be taxable income just like any other distribution received from an IRA.

The thing that I don't know is whether the SPIA would be subject to the 10% early distribution penalty if you are less than 59 1/2 when you receive them. Check with your IRA/annuity provider.

 

[obgyn65]

Hello again, pb4uski, and thank you for your help with my questions under this thread. If there are no tax implications if my IRA buys an SPIA, when do I pay my taxes on my pre tax contributions that were originally in my traditional 401k ? If only the SPIA payments get taxed, I am wondering why not more people are doing it...

There are no tax implications when you rollover your 401k to an IRA (as long as you do a direct rollover where the money goes directly from your 401k provider to your IRA provider). Similarly, there would be no tax implications if your IRA buys a SPIA.

SPIA payments you receive would be taxable income just like any other distribution received from an IRA.

The thing that I don't know is whether the SPIA would be subject to the 10% early distribution penalty if you are less than 59 1/2 when you receive them. Check with your IRA/annuity provider.

 

[MichaelB]

There are no tax implications when you rollover your 401k to an IRA (as long as you do a direct rollover where the money goes directly from your 401k provider to your IRA provider). Similarly, there would be no tax implications if your IRA buys a SPIA.

SPIA payments you receive would be taxable income just like any other distribution received from an IRA.

The thing that I don't know is whether the SPIA would be subject to the 10% early distribution penalty if you are less than 59 1/2 when you receive them. Check with your IRA/annuity provider.

+1

Hello Michael. I guess the confusion comes from the fact that 1) I did not mention that my 401(k) is a traditional one 2) pb4uski above wrote "The smart play would be to convert the 401k to an IRA and have the IRA buy the SPIA so while there would be no upfront tax if done correctly, the SPIA payments would be taxable income."

My 401(k) plan is a traditional 401(k) = taxes on contributions have been not paid yet. Therefore my question is : if my withdrawals are taxed when I reach 60, how can I avoid these taxes by converting my 401k to an IRA and then have the IRA buy the SPIA ?

Still not clear to me, sorry.

Oby, in your original post you are computing full 22% tax twice. First, on the 401k, then on the entire SPIA distribution

+(178000*1.015^13*0.78)*0.05*0.78

Your tax liability for the SPIA would only be the portion in excess of what you paid in. If you were to convert the 401k to an IRA, then buy the SPIA, your calculation would be

+(178000*1.015^13)*0.05*0.78

 

[obgyn65]

Well I guess I will call my 401k provider. If you are right, Michael, this will increase my annual withdrawals by another $2k or $3k / year.

I love this website. Learning a lot. Thanks everyone.

 

[pb4uski]

Hello again, pb4uski, and thank you for your help with my questions under this thread. If there are no tax implications if my IRA buys an SPIA, when do I pay my taxes on my pre tax contributions that were originally in my traditional 401k ? If only the SPIA payments get taxed, I am wondering why not more people are doing it...

Think of it this way - you generally get taxed on any IRA withdrawals once you receive them and have freedom to spend the money as you wish.

So the payments that the SPIA owned by your IRA makes to you are taxable income to you in the year that you receive them just like other IRA withdrawals are taxable in the year you receive them.

If one purchases a SPIA with taxable funds, then only a portion of the SPIA payments are taxable since a portion is a return of principal. However, in the situation that we are talking about since the SPIA was purchased with tax deferred funds, then the whole SPIA payment is taxable.