Flattening the Tax Curve (withdrawing funds for second home)

[Clone]

We are considering buying a second home for winter (probably about 12 to 18 months from now). I would prefer to just pay cash for it. I am looking at schemes to pull funds from assorted sources in an effort to flatten the curve of the impact to taxes. My initial thought was to pull money from the 401k in late 2021, and hold it in cash. Then pull additional money from the 401k in 2022. Additional funds could come from a 50k loan against the 401k, which could then be paid off in 2023, and finally a pull from the Roth account.

The alternative is to just continue to max the Roth conversions, and pull the whole thing from the Roth account. Assuming that there is no change in tax rates, ignoring market performance, and that withdrawal/conversions are done to the same incremental tax rate- Are these approaches equivalent? The loan is just pulling money from 2023 into 2022, but it is no different than pulling money from a Roth (just pushing the tax obligation out into 2023)?

We have been building up the Roth accounts by doing conversions, and it seems that I have built a mental wall that says to continue building but don’t draw from them. Much like the transition from accumulating mode to spending down mode, I think I am just a bit hung up on this. I would appreciate any thoughts to help me clarify my thinking.

 

[Ronstar]

Don’t Roth contributions have to be in the account for 5 years before you can withdraw?

Given the short time frame, I would make IRA withdrawals into a taxable account. And I would consider a mortgage to cover any shortfall.

 

[WyomingLife]

We are considering buying a second home for winter (probably about 12 to 18 months from now). I would prefer to just pay cash for it. I am looking at schemes to pull funds from assorted sources in an effort to flatten the curve of the impact to taxes. My initial thought was to pull money from the 401k in late 2021, and hold it in cash. Then pull additional money from the 401k in 2022. Additional funds could come from a 50k loan against the 401k, which could then be paid off in 2023, and finally a pull from the Roth account.

The alternative is to just continue to max the Roth conversions, and pull the whole thing from the Roth account. Assuming that there is no change in tax rates, ignoring market performance, and that withdrawal/conversions are done to the same incremental tax rate- Are these approaches equivalent? The loan is just pulling money from 2023 into 2022, but it is no different than pulling money from a Roth (just pushing the tax obligation out into 2023)?

We have been building up the Roth accounts by doing conversions, and it seems that I have built a mental wall that says to continue building but don’t draw from them. Much like the transition from accumulating mode to spending down mode, I think I am just a bit hung up on this. I would appreciate any thoughts to help me clarify my thinking.

Hope you are safe and healthy.

I don't think we have enough information. Age? Budget? NW? etc., etc., etc.

 

[Sunset]

With mortgage rate so low, why not simply get a mortgage for as much as you possibly can.

The advantage, besides letting your stock values recover is that getting a mortgage really pulls into focus the fact that a 2nd home costs $$$.
Either it costs in terms of mortgage, or lost potential income from the investment money used to buy it.

If you want to use the argument that the 2nd home will appreciate in value so does not cost lost investments, then the same argument can be applied to the mortgage, saying that the cost of the mortgage will be compensated by the appreciation of the 2nd home, so in essence the cost is free.
You could possibly mortgage the entire amount, but getting a mortgage on the 1st home and the 2nd home combined to equal the purchase price.

 

[Animorph]

In general doing a Roth conversion and then withdrawing it is the same as just withdrawing that amount from the 401k. If everything happens at the same tax rate the only advantage of a Roth conversion is moving some of your taxable account funds (the tax amount you paid) into the Roth. It grows tax free in the Roth, so you save the taxes you would have paid on that amount in future years. If you Roth convert and then immediately withdraw from the Roth that money has had no time to grow and you have saved nothing. Roth conversions will work best when withdrawals are still a few years away.

Breaking up the 401k withdrawals into two (or three?) different years should help level your taxes. But the effects will depend on your specific tax situation. Maybe you can take it all out in one year at 22% marginal rate, or maybe you'll need to divide it into two or three parts to stay within the 22% rate. Or whatever rate comes next for you.

Can you raise money from taxable accounts within the 0% capital gains tax bracket? That would be your best bet. Not sure I'd be making major purchases out of a 401k with the large tax impact. And your instincts on not withdrawing from the Roth are good.

 

[pb4uski]

Don’t Roth contributions have to be in the account for 5 years before you can withdraw?...

Contributons can be withdrawn without tax or penalty at any time.

But the OP is talking about conversions, not contributions. If OP is over 59 1/2 and Roth is over 5 years old then all withdrawals are not taxable. If OP is over 59 1/2 and Roth is less than 5 years old then only withdrawals of earnings taxable.

--------------------------------------------------
Re: Roth IRA Rules - Table Approach
Posted by: KAWill (IP Logged)
Date: October 14, 2010 11:57PM


Roth IRA Distribution Table

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD NOT MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-Yes (Taxable Portion)
Conversions: Tax-No ;Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

UNDER AGE 59.5
FIVE YEAR CONVERSION HOLDING PERIOD MET

Contributions: Tax-No; Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-Yes

OVER AGE 59.5
LESS THAN FIVE YEARS SINCE OPENING FIRST ROTH IRA

Contributions: Tax-No ;Penalty-No
Conversions: Tax-No; Penalty-No (Taxable Portion)
Conversions: Tax-No; Penalty-No (Nontaxable Portion)
Earnings: Tax-Yes; Penalty-No

OVER AGE 59.5
FIVE YEARS OR MORE SINCE OPENING FIRST ROTH IRA

All Distributions Are Qualified

 

[pb4uski]

I think I would continue Roth conversions and then if you end up buying a second home in 12-8 months then assess how bet to pay for it at that time.

Harley has been having issues getting refinancing for a second home IIRC and I suspect that new mortgages for second homes are probably not so easy to get right now given the uncertainty if the borrower will continue to have income to make the payments on the loan. But it might be very different in 12-18 months... or not.

 

[Clone]

I guess if I look at it in pieces, it becomes a bit clearer.

There is no difference in making a Roth conversion, and then cashing out the contribution amount. Thus, rather than withdraw from the 401k and hold as cash, just put it into the Roth. I have enough contributions amount in the Roth to cover the purchase amount, so that portion of the Roth just looks like a big checking account. And rather than pull some from the Roth and some from the 401k, I can just write the check from the Roth, and later Roth convert some of the 401k. The 401k loan would let me push some taxes into a future year, and could be paid off from after tax sources (if there is sufficient cash flow to still generate income above the burn rate. Right now, I am not tapping the tax deferred for living expenses. So far, the pension plus other income streams has been covering living expenses.

I guess this falls into the money is fungible category, so spend after-tax money first, then Roth. I can always refill the Roth from the 401k over time.

 

[kaneohe]

......................................................................
There is no difference in making a Roth conversion, and then cashing out the contribution amount. Thus, rather than withdraw from the 401k and hold as cash, just put it into the Roth. I have enough contributions amount in the Roth to cover the purchase amount, so that portion of the Roth just looks like a big checking account. .....................................................

It is not clear from your statement above if you understand the Roth withdrawal process. When you make a Roth conversion, you make a conversion contribution. Depending on your age , there may be consequences of withdrawing that conversion contribution that are different from withdrawing an original Roth contribution. See the table posted above by pb4uski.

 

[Clone]

See the table posted above by pb4uski.

What I see: I am over 59.5, therefore I can withdraw the contribution amount without paying taxes or penalty.

Basically, below age 59.5 you cannot use the contribution portion like a rainy day fund. After 59.5, it looks to me that you can Roth convert, and then at any time in the future you can withdraw up to the contribution amount without tax or penalty. If you withdraw any of the earnings before the account has been open for 5 years, then you pay taxes on those earnings. So before the 5 year mark a person should keep track of the contributions amount just to make sure that you don't get into the earnings.

Thank you for pointing this out. I had seen that chart before, but did not notice the conversions line. Since I am over 59.5, it does not make a difference. But I had not understood that aspect of it.

 

[kaneohe]

What I see: I am over 59.5, therefore I can withdraw the contribution amount without paying taxes or penalty.

Basically, below age 59.5 you cannot use the contribution portion like a rainy day fund. After 59.5, it looks to me that you can Roth convert, and then at any time in the future you can withdraw up to the contribution amount without tax or penalty. If you withdraw any of the earnings before the account has been open for 5 years, then you pay taxes on those earnings. So before the 5 year mark a person should keep track of the contributions amount just to make sure that you don't get into the earnings.

Thank you for pointing this out. I had seen that chart before, but did not notice the conversions line. Since I am over 59.5, it does not make a difference. But I had not understood that aspect of it.

sounds like you have it down pat. We didn't know your age and I would make an effort to use more conventional terminology so you don't get misunderstood.
"Contributions" are more conventionally used to mean original Roth contributions where you contributed directly to a Roth w/ an annual limitation.
"Conversions" or less commonly "conversion contributions" is used to mean the amounts you convert from a TIRA or perhaps a company retirement plan .