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tax averaging
Old 08-27-2005, 02:49 PM   #1
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tax averaging

I'm new here plan early retirment in Feb '06. In 5 years I would like to pay off my house, $170,000. If I pay with 401K money can I average the money (4 years) for tax purposes so I don.t get hit with high taxes? Thanks...KJ
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Re: tax averaging
Old 08-28-2005, 08:23 AM   #2
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Re: tax averaging

Sorry, no income averaging anymore. (unless you are a farmer).
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Re: tax averaging
Old 08-28-2005, 11:31 AM   #3
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Re: tax averaging

It's hard to comment fully without knowing your age and other circumstances. One strategy that might take some of the sting out of the tax bite would be this:

1. After you leave the job in 2006, transfer the 401k to traditional IRA.

2. Each year, convert enough $$ from the traditional IRA to a Roth IRA without bumping yourself up into the next tax bracket. You'll have to pay tax on the conversion amount, but hopefully at a lower rate than if you took all the money out in a big chunk later.

3. When you are ready to pay off the house, you can withdraw money from the Roth IRA without penalty, as long as you limit the withdrawal to prior contributions and conversions only. The IRS considers Roth money to be withdrawn in the following order:
* *-- contributions first
* *-- conversions next
* *-- earnings last

Leave the earnings and any of your prior contributions in the Roth. The conversions can be withdrawn tax-free at this point because you've all ready paid the taxes due when you did the conversions piece-meal in prior years.

Keeping good records of the transactions related to the Roth is a must.

This will spread the pain of the taxes due over a period of years and allow the earnings (and any previous contributions) in the Roth to compound and grow tax free.

If you will be less than 59 1/2 years old at the time you make the withdrawals from the traditional IRA to pay off the house, you'll have to factor in a 10% penalty on the amount you withdraw from the traditional IRA PLUS the regular income tax you'll owe on it.

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Re: tax averaging
Old 08-28-2005, 07:08 PM   #4
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Re: tax averaging

How old are you? You might not want to rollover into an IRA if you are less than 59.5. For a 401(k), I believe there is no penalty for distributions made to an employee after leaving employment if the employee turns 55 that year. However, the employer doesn't have to allow you to spread out the withdrawls and might make you take the amount you want to withdraw all at once. This can lead to a big tax bill.

One option to look at is rolling over into an IRA and then taking early withdrawls under the "substantially equal periodic payments rule."
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Re: tax averaging
Old 08-31-2005, 01:53 AM   #5
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Re: tax averaging

I'll be 55, I'll have about $1850 a month from a pension and plan on either selling my house in 5 years or paying it off with the IRA money. I'll have about $400,000 to roll from the 401 to the IRA and plan on taking the SEPP payment setup for 5 years from IRA. After 5 years and 1 day I can pull the IRA money out. I was unaware income averaging was no longer allowed. Thanks for the info, I plan on setting up an appointment with a Fidelity planner to talk about all this.
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Re: tax averaging
Old 08-31-2005, 07:59 AM   #6
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Re: tax averaging

If you are 55 when you retire, you might be able to keep the 401(k) and take distributions from it to pay down the mortgage on your house. No 10% penalty if you leave your job in the year you turn 55, but you will have to pay taxes on the distributions. Therefore, you might want to consider this option as welll
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Re: tax averaging
Old 08-31-2005, 09:07 AM   #7
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Re: tax averaging

Why do you want to pay off the house? If you are in the first 10 years of so of the loan your mort. interest is deductable. If you are going to sell the house in 5 years anyway, I am not sure what advantage, other than cash flow, you will gain buy paying it off.

Using 401(k) assets for this would seem to be a waste of the tax savings associated with this kind of account (deferred taxes). I am no expert on this but it looks to me like you might be better off just paying on the house until you sell it rather than taking a tax hit using your 401(k) or using other after tax money that could be invested to create an income stream for you.
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Re: tax averaging
Old 08-31-2005, 09:47 PM   #8
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Re: tax averaging

Quote:
Originally Posted by SteveR
Why do you want to pay off the house?* If you are in the first 10 years of so of the loan your mort. interest is deductable.* If you are going to sell the house in 5 years anyway, I am not sure what advantage, other than cash flow, you will gain buy paying it off.*
I would only pay it off if I decided to stay in California. I may just sell within 5 years and move to Nevada. I'm just looking at different options.
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