Solo/Individual 401(k) vs taxable account

[someguy]

Hi All,

You can read a more detailed intro here, but in short summary the DW and I have around $100K/year for savings/investment and we have a lot of options due to having an individual 401(k) which allows profit sharing. We hope to semi-retire in about 10 years when we're in our 40's. I am struggling with how to allocate dollars earmarked for savings/investment in terms of the i401(k) versus taxable accounts.

Would it be best to allocate as many dollars as possible into the pre-tax i401(k) and then, if taxable accounts are emptied before we can begin normal 401(k) withdrawls, do Roth conversions? I expect earned income during semi-retirement will be lower than it is now. Does anyone know if it's even possible to do Roth conversions out of an individual 401(k)? Would I have to roll over the i401(k) into a rollover IRA and then do the Roth conversion?

Thanks for your thoughts.

 

[samclem]

Okay, I'll take a swing at it . . .

Would it be best to allocate as many dollars as possible into the pre-tax i401(k) and then, if taxable accounts are emptied before we can begin normal 401(k) withdrawls, do Roth conversions?

The best method for drawing down your accounts in order to reduce taxes is a complex problem with several different variables. I recommend you spend a few hours with i-orp . Try lots of different approaches and get an appreciation for the impact of the various tax laws on your situation.

Does anyone know if it's even possible to do Roth conversions out of an individual 401(k)? Would I have to roll over the i401(k) into a rollover IRA and then do the Roth conversion?

When you say "Roth Conversion" do you mean a conversion to a Roth 401K or to a Roth IRA? Anyway--both are possible.

I think many people rollover their solo 401K accounts to traditional IRA's when they are retired (in this case, that means they have dissolved their business and aren't making contributions anymore). That's probably what I'll do. There's just a bit less paperwork/reporting with the IRA. Before you do, search around to make sure there are no subtle differences that could be a "gotcha." For instance, if you quit/get fired/etc in the year you reach 55 you are allowed to take withdrawals from your 401K without penalty--I don't think there's a similar provision with IRAs, so you'd need to wait until 59 1/2 (of course you can take 72t SEPPs with either type of account).

Anything that remains in your (non-Roth) 401K or IRA when you reach 70 1/2 will be subject to required minimum distributions, and these can drive your taxable income higher than you might want, so moving funds to Roth accounts may make a lot of sense for you. Your i-orp runs should make the impact of these RMDs pretty clear.

 

[someguy]

So am I correct in assuming, then, that we can only do Roth IRA rollovers from our i401(k)s if we are no longer "employed" by our small business which the i401(k) is under? Any idea what the exact definition there is? That would be disappointing, because the hope is to continue to hold part or all units in it throughout semi-retirement as an income stream.

I tried the calculator once and didn't seem to get info useful to my question out of it, but I need to spend more time learning it (I'm mostly familiar with firecalc).

 

[Animorph]

So am I correct in assuming, then, that we can only do Roth IRA rollovers from our i401(k)s if we are no longer "employed" by our small business which the i401(k) is under? Any idea what the exact definition there is? That would be disappointing, because the hope is to continue to hold part or all units in it throughout semi-retirement as an income stream.

I tried the calculator once and didn't seem to get info useful to my question out of it, but I need to spend more time learning it (I'm mostly familiar with firecalc).

You need to read the documents from when you started your i401k. Mine allowed an in-service withdrawal/conversion option, though I don't remember if I checked that box. Quite likely you could change it on the fly anyway, since a lot of that paperwork is stuff you fill out, sign, and then stuff in your file cabinet without having to send it to anyone else.

In general, you want to fill up your lowest tax bracket, either with conversions while you live on taxable accounts or later with pre-tax account withdrawals supplemented with Roth withdrawals if necessary. But obviously your specific details will dictate the exact amounts you would want to use.

 

[samclem]

So am I correct in assuming, then, that we can only do Roth IRA rollovers from our i401(k)s if we are no longer "employed" by our small business which the i401(k) is under? Any idea what the exact definition there is?

As Animorph said, you'd need to check the wording of your plan agreement. As a practical matter, if the document doesn't allow for in-service transfers you might just be able to say you shut down that business and roll over all funds to an IRA. If you choose, re-open a new individual 401K the following month under a new business name (with a new Employer ID number) so you can make more contributions . I'm not an attorney or an accountant, so definitely check this out further. But I can't see why you, as the business owner and employer couldn't choose to cease one business and stand up another one right away.