High 401k contribution

[Alex The Great]

I plan to retire in late February next year. In order to minimize earned income tax, my plan is to substantially increase 401K contribution for Jan and Feb such that I earn virtually nothing in 2023. Are there any hidden issues with that? Did anyone else use this trick?

 

[Vacation4us]

You are only limited by your employer. No issue contributing high % if they allow it.

 

[mpeirce]

I plan to retire in late February next year. In order to minimize earned income tax, my plan is to substantially increase 401K contribution for Jan and Feb such that I earn virtually nothing in 2023. Are there any hidden issues with that? Did anyone else use this trick?

Yes. I basically had no take-home pay that last month of working (January for me).

Another way to get money into tax advantaged accounts is a HSA if you have one. I was lucky in that the company added in their yearly HSA funding into my HSA, plus what I was able to shovel into it. Win win.

 

[Alex The Great]

Thanks. Indeed I might need to check with employer.

 

[Alex The Great]

Another way to get money into tax advantaged accounts is a HSA if you have one. I was lucky in that the company added in their yearly HSA funding into my HSA, plus what I was able to shovel into it. Win win.

Good to know that it worked for you. Yes I do have HSA but increase in contribution is challenging with my employer and contribution itself is too small compared to pay check.

 

[cathy63]

I plan to retire in late February next year. In order to minimize earned income tax, my plan is to substantially increase 401K contribution for Jan and Feb such that I earn virtually nothing in 2023. Are there any hidden issues with that? Did anyone else use this trick?

Yes, I did this. I just had to make sure to have enough remaining income in my check to cover my health insurance premiums.

 

[Al18]

If you are retiring prior to taking SS, then you would need to consider how big your cash bucket is to live off 3 years without selling stocks at a loss.

When I retired, I decided to cut my 401k contributions the last few months to increase my cash/CD reserves.

 

[DawgMan]

I plan to retire in late February next year. In order to minimize earned income tax, my plan is to substantially increase 401K contribution for Jan and Feb such that I earn virtually nothing in 2023. Are there any hidden issues with that? Did anyone else use this trick?

Well, not sure we have enough details of your situation, but I retired around March this year with relatively little earned income compared to years past. My DW and I are the only W2 employees of my company. For this year, my DW’s and my W2 income will effectively be canceled out by our 401k contributions. I will still have biz profits to account for, however they are subject to biz expenses. Probably different than your situation, but is a trick?? I guess kinda sorta. Get a good accountant if you are not sure.

 

[Alex The Great]

If you are retiring prior to taking SS, then you would need to consider how big your cash bucket is to live off 3 years without selling stocks at a loss.
When I retired, I decided to cut my 401k contributions the last few months to increase my cash/CD reserves.

Thanks this is definitely an important point. I still have almost 15 years till SS as I plan to take it at 70. But I do not plan on selling stock either as I have enough cash/dividends to live for ~5 years and also can utilize 55 rule to take some money out of 401K (it is all in CDs and stable value fund) if necessary.

 

[Alex The Great]

Well, not sure we have enough details of your situation, but I retired around March this year with relatively little earned income compared to years past. My DW and I are the only W2 employees of my company. For this year, my DW’s and my W2 income will effectively be canceled out by our 401k contributions. I will still have biz profits to account for, however they are subject to biz expenses. Probably different than your situation, but is a trick?? I guess kinda sorta. Get a good accountant if you are not sure.

Thanks for the info. But my situation is a bit different as I work for a large company and all I have is earned income reported in W2.

 

[CDRE]

Yes, and I made sure I received the Company percentage match. Since the company match was allocated each month, I made sure that my monthly contributions did not reach the IRS yearly allowed maximum in any month before my end date month. No need to forego free Company money by ending my contributions early.

 

[Mark1]

I did this for many of my last years as I wanted to be prepared just in case a severance package came along (I was able to leave at 70 points with severance, but need to wait until 80 points to leave on my own and get retirement medical, etc).

I also did the same thing maxing out my employee stock purchase program. I left in 4/2016 and got ~$3,000 discount on stock purchase on 1/2017. Therefore, I had ~$3,000 wages in 2017 which I was now able to contributed to my Roth IRA that year (obviously I had to stay within the proper tax bracket range that year, as well).

 

[Texas Proud]

The only thing that I would look at that I did not see mentioned is... will your taxable income now be so low that you lose a lot of the 15% tax bracket?


Unless your are going into ACA and want to keep your income down I would want to max out my 15% bracket...

 

[copyright1997reloaded]

I plan to retire in late February next year. In order to minimize earned income tax, my plan is to substantially increase 401K contribution for Jan and Feb such that I earn virtually nothing in 2023. Are there any hidden issues with that? Did anyone else use this trick?

I plan to do something similar, except I am attempting to max out my 403(b) Roth in 2023 before I leave my teaching job. (It will be $30,000 in 2023.)

Hopefully I will be able to do that AND perhaps a bit of Roth conversion.

 

[Alex The Great]

The only thing that I would look at that I did not see mentioned is... will your taxable income now be so low that you lose a lot of the 15% tax bracket?


Unless your are going into ACA and want to keep your income down I would want to max out my 15% bracket...

Sorry I think I miss your point. Why is this so important to max out 15% bracket? Most likely I will be on Cobra next year.
In addition to earned income I still have some passive income which would still keep me in 12% bracket. But the main reason I want to minimize earned income is Roth conversion I plan to do that year on top of passive income.

 

[Accidental Retiree]

Good to know that it worked for you. Yes I do have HSA but increase in contribution is challenging with my employer and contribution itself is too small compared to pay check.

If you have an HSA and the appropriate high-deductible health plan continues after your employment ends, you can contribute enough to meet your yearly contribution limit outside what your employer offers.

If you need a 2nd HSA account to do this, Fidelity offers a no-fee HSA.

 

[Exchme]

Sorry I think I miss your point. Why is this so important to max out 15% bracket? Most likely I will be on Cobra next year.
In addition to earned income I still have some passive income which would still keep me in 12% bracket. But the main reason I want to minimize earned income is Roth conversion I plan to do that year on top of passive income.

You are on the right track. First, the 15% bracket became 12% with the TCJA several years ago. That law expires after 2025, but currently there is no 15% bracket.

Second, filling the 12% bracket with Roth Conversions can be a great idea, with one caveat. There is a phase-in of taxes on long term capital gains (LTCGs) that starts when your AGI (sum of ordinary income + LTCG) hits the top of the 12% bracket. If you do Roth Conversions beyond that, then those last dollars are themselves taxed at 12%, plus they push an equal amount over the capital gains phase-in, so you pay 15% on that. Meaning that those last $s are taxed at 27%!

Once all of your LTCGs are taxed, then your marginal rate falls back to 22%. So folks doing Roth Conversions always have to decide whether to stop just before LTCGs get taxed or push through that 27% zone to get to the 22% bracket.

 

[Aerides]

It all depends on your MC and how much you are able to contribute in each check. Some won't let you do more per pay period, some will. I did it your way. I wasn't sure when my last day would be, but I wanted to max before end of 1Q.

At my MC it was a simple tool in our plan settings that I could manage. I set my contributions to something near 60% of my paycheck.

But yes you also want to make sure you have ample non-taxable savings. It's a balance many forget to make.

 

[Alex The Great]

Second, filling the 12% bracket with Roth Conversions can be a great idea, with one caveat. There is a phase-in of taxes on long term capital gains (LTCGs) that starts when your AGI (sum of ordinary income + LTCG) hits the top of the 12% bracket. If you do Roth Conversions beyond that, then those last dollars are themselves taxed at 12%, plus they push an equal amount over the capital gains phase-in, so you pay 15% on that. Meaning that those last $s are taxed at 27%!

Once all of your LTCGs are taxed, then your marginal rate falls back to 22%. So folks doing Roth Conversions always have to decide whether to stop just before LTCGs get taxed or push through that 27% zone to get to the 22% bracket.

Thanks Exchme, this is a very useful info. I can see the meaning of 15% now.
For federal and state tax estimation purpose I use this calculator:
https://www.irscalculators.com/tax-calculator
I'm trying to stay within 12% bracket for Roth conversion, with maximum amount provided by this calculator (which is around $54K in my case). Hope situation you described is built into it.

 

[Finance Dave]

Sorry I think I miss your point. Why is this so important to max out 15% bracket? Most likely I will be on Cobra next year.
In addition to earned income I still have some passive income which would still keep me in 12% bracket. But the main reason I want to minimize earned income is Roth conversion I plan to do that year on top of passive income.

Why would you choose Cobra? Unless your income is very high, Cobra will be more expensive.

 

[Alex The Great]

Why would you choose Cobra? Unless your income is very high, Cobra will be more expensive.

Why do I choose Cobra? The main reason are Roth conversions. I compared the cost of ACA Blue California HDHP PPO plan available in my area and Cobra provided by current employer and ACA cost is higher because of high deductible $7K and high premium $860 per month based on $80K MAGI with total estimate $12.27K per year. Cobra would cost around $10.5K per year. I did more comparisons and discovered the ACA cost become comparable to Cobra with MAGI less than $50K. Besides that, Cobra most likely has better coverage.
This is why my plan is to do higher Roth conversions for the first 1-2 years then get MAGI below $50K and use ACA.

 

[Big_Hitter]

I plan to retire in late February next year. In order to minimize earned income tax, my plan is to substantially increase 401K contribution for Jan and Feb such that I earn virtually nothing in 2023. Are there any hidden issues with that? Did anyone else use this trick?

that's what I did