Downside to withdrawing from 401K at 59.5?

[ImReady]

Hello All:

Getting ready to FIRE at 59 (after a few OMYs) and wanted to get your thoughts on the best withdrawal strategy.

Expenses are about $80K a year and I have $2.8M in investments broken down as follows:
$1.5M taxable
$750K my 401K
$350K DW and my IRAs
$200K cash

Will wait until 70 to take $65K in social security income (me and DW combined)
Both taxable and 401K/IRA investments are about 60/40 equity/bond funds. I'd rather not touch my principal, so my idea is simply to use the dividends and capital gains from both my $1.5M taxable and $750K IRA account to cover my $80K expenses. If I only use the income from my taxable account, it will generate around $60-65K depending on the year.
I heard a lot of folks on this site recommend waiting to until 70 to start drawing from a 401K for tax reasons, but I don't see a big difference between using it now or then, esp. since I'll have SS income at 70.
So the question is, should I only touch the taxable income until 70, which means I will have to sell some of the principal each year, or start taking the income from the 401K as soon as I'm eligible?

 

[Big_Hitter]

managing MAGI is the key if you want an ACA subsidy

 

[MBAustin]

Welcome ImReady! If you haven't seen them yet, there are two excellent resources here that have a lot of useful information as you prepare to FIRE:

http://www.early-retirement.org/forums/f47/some-important-questions-to-answer-before-asking-can-i-retire-69999.html

and

Early Retirement FAQs - Early Retirement & Financial Independence Community

For complex modeling, a number of folks here use the iORP calculator, so you might want to give that a try.

 

[pb4uski]

....So the question is, should I only touch the taxable income until 70, which means I will have to sell some of the principal each year, or start taking the income from the 401K as soon as I'm eligible?

We have similar numbers and for us the best answer is "Yes".

We are living off of our taxable investments, including principal as necessary, and also doing low tax cost Roth conversions from our tax-deferred IRAs to the top of the 15% tax bracket to help reduce RMDs later in life and build up our tax-free portfolio. The last few years we have paid ~7% federal and 3% state tax on the amounts we converted... absent conversions our federal tax would be nil.

We decided that the benefit of a low tax cost Roth conversions exceed the value of ACA subsidies for us.

 

[RunningBum]

There is nothing magical about your principal that you can't touch it. I suggest you put together a spreadsheet analyzing various strategies including converting part of your IRA to a Roth, getting an ACA subsidy if that is possible, and the effect MRDs will have on your 401K/IRAs at 70. Include taxes and estimated growth of your investments. Try to minimize taxes over the long haul.


I suspect that either through taken distributions early or doing Roth conversions, you'll want to start reducing your IRA/401K early to avoid large MRDs.


Everyone's situation is a little different and factors like how much unrealized gains you have in your taxable portfolio and what kind of investment return you feel comfortable predicting make it difficult to give general advice.

 

[Youngster]

Thanks for the thread, ImReady. Although you are finacially much better off than I am, I was researching the same question just yesterday.

I am retired for a year now, and will not be 59 1/2 until 2017. I am thinking of starting to take out of the 401k and IRA after spouse stops working which should be soon after I reach 59 1/2. We are doing fine right now at our level of income, so I would only withdraw enough to make up for spouse's part time employment income, until I am 62 (or longer, depending on the state of SS when I turn 62).

Hopefully SS will be fine for a long time; then I can wait for the higher payout while withdrawing from the 401k.

Not sure yet if this is the route I will go. I still have time for further research.

 

[eta2020]

managing MAGI is the key if you want an ACA subsidy

That is exactly what crossed my mind.

And if some of that 401k IRA is Roth then you can draw it before you are 65 (Medicare age) and it will not count as income in MAGI.... hence cheap Obamacare. If not sell from taxable where only capital gains are part of MAGI.

 

[skibum]

Being ER'd with minimal regular income and the ability to draw on both taxable and tax deferred income provides some interesting tax savings opportunities. Typical strategies are to convert tIRA to Roth IRA up to the top of the 15% tax bracket (or ACA cliff), withdraw from tIRA/401k to this limit, or harvest capital gains.

The Boglehead post below opened my eyes to tax opportunities in ER. Second link from Kitces illustrates the zero percent tax on qualified dividends and long term capital gains in the 15% bracket.

I would not hesitate to sell off taxable assets for living expenses, hopefully taking advantage of zero LTCG bracket, then convert from tIRA to Roth up to the applicable limit. iORP provides some projections as referenced in bogglehead post, you will probably want to create your own spreadsheet. There is some merit to taking tIRA withdrawals at these low tax rate(s), but this essentially converts the pre-tax funds to after tax funds rather than Roth funds. With your significant after tax balance, there will likely be a long term benefit to convert rather than withdraw tIRA$ while living off after tax funds.

https://www.bogleheads.org/forum/viewtopic.php?t=87471

https://www.kitces.com/blog/understa...p-up-in-basis/

 

[meierlde]

managing MAGI is the key if you want an ACA subsidy

Just to note that MAGI also affects part B&D premiums as well. The increase here starts at 85k single 170k married filing jointly.

 

[N02L84ER]

I agree with the other posters and specifically with this part of skibum's post.

With your significant after tax balance, there will likely be a long term benefit (overall lower taxes paid) to convert (to Roth to the top of the 15% bracket) rather than withdraw tIRA$ (for living expenses) while living off after tax funds (until RMDs hit).

 

[pb4uski]

..... I am retired for a year now, and will not be 59 1/2 until 2017. I am thinking of starting to take out of the 401k and IRA after spouse stops working which should be soon after I reach 59 1/2. ....

Just in case you don't know, you can do Roth conversions (which is a form of distribution from a 401k or tIRA but into a Roth) at any age.

 

[panacea]

All pretty well covered I think. I'm a few years off but I expect my mix will look something like yours, leaning a bit more toward qualified assets. Here's my plan:

1) Mostly draw from taxable accounts for living expenses through Social Security age
2) Max HSA contributions annually
3) Roth conversions near top of 15% of tax bracket...
4) but leaving some room for tax subsidy until age 65 (will have to see what that looks like later)
5) Maintain 50-50 asset allocation in taxable account; withdraw monthly pro rata across all funds to help maintain allocation

 

[ImReady]

Thanks All for the replies. I'll look into the Roth conversions on my 401K up to the 15% tax bracket and the potential for ACA subsidies. I still have a lot to learn in terms of maximizing tax efficiencies.