Tax avoidance strategies for withdrawal from large 401k?

[TonyClifton]

Because my natural tendency is to save instead of spend I have accumulated quite a lot in my 401k(s). I've suddenly sat bolt upright in my chair realizing I may have saved too much, at least as far as tax avoidance is concerned which is a major reason for 401ks and their tax advantages.

Not wanting the heirs to deal with the tax complications of inheriting untaxed money, I'm interested in systematically withdrawing up to the limit of whatever tax bracket is appropriate, in this case currently 24%. The returns on that money reinvested though keeps pushing the income up, so again, higher tax brackets loom. I know, most folks should have this problem (heh), no argument there.

I'm thinking one strategy is to invest withdrawn money in individual stocks of no or low dividend payout, so annual proceeds are low and then it's just LT capital gains that are due when they're sold.

Does anyone know of strategies similar to what I've described to achieve the goal of 401k withdrawals that avoid the high taxes we were trying to avoid in the first place?

 

[RunningBum]

It sounds like you either aren't yet 72 (age at which RMDs are required), or you are taking out over and above your RMD. Rather than withdrawing the funds, why don't you convert them to a Roth IRA, where they will grow untaxed? You may have to do the intermediate step of rolling the 401K to an IRA first, but that shouldn't be a big deal. The conversion is taxed just like your withdrawal, but you don't have to worry about investing with low taxes in mind inside the Roth.

 

[TonyClifton]

Thanks for the reply! Not wanting to write a book in the first post I was spare with the details. I'm just shy of 59 and will retire at 61. Our income goes up and down but is usually too high to qualify for Roth IRA contributions, but I can sometimes. What I am talking about is $2 million currently in 401k, a bit higher balance in two more years. My initial pension will be $75k/yr adjusted annually for inflation.

 

[MichaelB]

Thanks for the reply! Not wanting to write a book in the first post I was spare with the details. I'm just shy of 59 and will retire at 61. Our income goes up and down but is usually too high to qualify for Roth IRA contributions, but I can sometimes. What I am talking about is $2 million currently in 401k, a bit higher balance in two more years. My initial pension will be $75k/yr adjusted annually for inflation.

I think a backdoor Roth might be an option. It’s worth looking into, and many members here are quite knowledgeable about the details.

 

[RunningBum]

Note that there is no income qualification to do Roth conversions. Conversions are not contributions. You can convert as much as you want.

 

[RetireBy90]

I am 64 and have about $1.5M in IRA, about $1M in TIRA and also worried about tax hit come 72. I am converting into 24% bracket, although just about $25K in the 24% to deal with much of the problem. Any funds left in TIRA I’m thinking of using QCD for the RMD at that point.
If you take draws from TIRA and move to taxable funds, any increase will be taxable unless you don’t sell anything for rest of your life. If you convert any growth will remain tax free for you and heirs. Why not convert ?

Here’s a couple threads that discuss Roth conversions
https://www.early-retirement.org/forums/f28/roth-conversion-help-103087.html

https://www.early-retirement.org/forums/f28/roth-conversion-taxes-perspective-i-needed-102073.html

https://www.early-retirement.org/fo...h-conversions-in-this-bear-market-102565.html

 

[CardsFan]

Unless you need the money, and it sounds like you don't, Roth CONVERSIONS, make a lot of sense.

Only you can decide how much and into what tax bracket you wan to go.

For us, retired, we can convert about $65k/year and stay in the 12% bracket. That is a no-brainer. Going higher requires some evaluation.

 

[Dtail]

Sounds like no ACA mgmt of monies comes into consideration.
Agree with possible backdoor Roth conversion.

 

[Dash man]

We’re both 63 with DW having $1.8M in a 401k an combined we have about $450k left in a tIRA. We converted a bunch of stock from the tIRA into a Roth in March when the markets ranked to take advantage of the low prices. It allowed us to move more shares at a lower price, meaning less taxes. We’ll likely go into the 24% bracket to move as much as we can over the next few years. I can’t help but believe tax rates will only go up in the future at some point. So I think it’s better to pay now.

 

[Montecfo]

Not wanting the heirs to deal with the tax complications of inheriting untaxed money, I'm interested in systematically withdrawing up to the limit of whatever tax bracket is appropriate, in this case currently 24%.

I know what you mean.

When I pass, I am sure my heirs will react poorly upon learning that I have left them tens or hundreds of thousands of dollars that are UNTAXED, including the money to pay those taxes.

" This was no man, this was a monster!", they will surely exclaim!

 

[Onward]

Inheriting a tax-deferred account isn't complicated. Your heirs withdraw the money and pay tax on it.

If I were in your shoes, I would either leave things as they are or, assuming you're over 59.5, withdraw up to the next tax bracket, pay the tax, and invest what's left in one or more low-fee index funds. Dividends are small and are taxed at a preferred rate. I can't see them affecting your tax situation much.

Individual stocks are a loser's game, IMO.

 

[RetireBy90]

Inheriting a tax-deferred account isn't complicated. Your heirs withdraw the money and pay tax on it.

If I were in your shoes, I would either leave things as they are or, assuming you're over 59.5, withdraw up to the next tax bracket, pay the tax, and invest what's left in one or more low-fee index funds. Dividends are small and are taxed at a preferred rate. I can't see them affecting your tax situation much.

Individual stocks are a loser's game, IMO.

Just curious, why take a withdraw rather than a Roth conversion ?
Both add to current year income, but with Roth that is last time IRS has any say about the funds.

 

[Onward]

Just curious, why take a withdraw rather than a Roth conversion ?

Roth conversion might be a better move, though there are some potential downsides like the 5-yr rule and the withdrawal requirements for beneficiaries.

 

[RunningBum]

Roth conversion might be a better move, though there are some potential downsides like the 5-yr rule and the withdrawal requirements for beneficiaries.

5 year rule is barely a factor. OP is still working and after retiring in two years could still withdraw living expenses from the 401K as they are doing today for three more years if needed. I'd open the Roth and fund it with a conversion right now to start the 5 year clock.

The beneficiary requirement is not a factor. At worst the beneficiary could take a lump sum distribution, which makes it the same as inheriting a taxable account. They could leave it to grow tax free for up to 10 years though.

 

[mystang52]

Isn't there an immediate tax hit when converting 401K to a Roth?;

 

[CardsFan]

5 year rule is barely a factor. OP is still working and after retiring in two years could still withdraw living expenses from the 401K as they are doing today for three more years if needed. I'd open the Roth and fund it with a conversion right now to start the 5 year clock.

The beneficiary requirement is not a factor. At worst the beneficiary could take a lump sum distribution, which makes it the same as inheriting a taxable account. They could leave it to grow tax free for up to 10 years though.

Not true. Taxable accounts get a step-up basis, as of the day of death.

 

[RetireBy90]

Isn't there an immediate tax hit when converting 401K to a Roth?;

There is a tax hit when doing a conversion, but there is also a equal hit if you do a withdraw. OP suggested he was considering taking withdraws and placing the funds into a taxable account. Same immediate tax hit.

 

[Markola]

Someone will have to pay tax on your pretax accounts, sooner or later. But you do have a choice to give to charity instead of the government. If you are charitably-inclined, you could keep things as they are and set up a charitable remainder unitrust (CRT) to receive the 401k funds at your death, which then will pay your heirs an annuitized income for their whole lives, with the remainder going to the designated charity/ies when they pass. It’s a common planning tool and Google will tell you all about it, if interested. I like this option for another reason, which is that it avoids the problems of dumping a bunch of cash on heirs who may have little skill at managing it. Instead, they just receive the quarterly CRT payments, which they can’t mess up.

 

[Alan]

The year I retired at age 55 I did a Roth conversion of my deductible IRA so only paid tax on the gains.

The following year I rolled my 401k into an IRA and have been doing Roth conversions every year since.

 

[gerntz]

Will heirs be in a higher tax bracket than whatever bracket you are withdrawing in? If you have several heirs and they each withdraw over 10 years, what bracket will they be in?

Bigger reason to withdraw now for me is I don't expect tax rates for the middle class to remain this low in the future given all the government spending.

 

[RunningBum]

Isn't there an immediate tax hit when converting 401K to a Roth?;

Yes, but OP is taking the very same tax hit doing withdrawals. By suggesting a conversion of the same amount rather than withdrawal, it's the same immediate tax hit.

 

[ut2sua]

Because my natural tendency is to save instead of spend I have accumulated quite a lot in my 401k(s). I've suddenly sat bolt upright in my chair realizing I may have saved too much, at least as far as tax avoidance is concerned which is a major reason for 401ks and their tax advantages.

Not wanting the heirs to deal with the tax complications of inheriting untaxed money, I'm interested in systematically withdrawing up to the limit of whatever tax bracket is appropriate, in this case currently 24%. The returns on that money reinvested though keeps pushing the income up, so again, higher tax brackets loom. I know, most folks should have this problem (heh), no argument there.

I'm thinking one strategy is to invest withdrawn money in individual stocks of no or low dividend payout, so annual proceeds are low and then it's just LT capital gains that are due when they're sold.

Does anyone know of strategies similar to what I've described to achieve the goal of 401k withdrawals that avoid the high taxes we were trying to avoid in the first place?

OP, you can do everything you stated, but if you take 1 more step to first convert your 401K monies to Roth by opening an IRA Roth account and put the $ in there, then you get everything you wanted except there is no LT capital tax to pay. You will need to report that on your tax return (the Roth conversion). As others have pointed out, with a Roth account, you need to open it for at least 5 years, then all monies will be tax free. If you have to withdraw before 5 years, then the capital gain portion may be taxed and/or penalized. The original converted amount should be tax free always. Do some research on Roth discussions in this forum to learn more. Lots of folks are making this similar move.

 

[Out-to-Lunch]

The year I retired at age 55 I did a Roth conversion of my deductible IRA so only paid tax on the gains.

Just for clarity, you meant NON-deductible IRA, right?

Sorry if this seems like picking nits. I was momentarily confused, so others may be too (assuming I am correct).

 

[RunningBum]

Not true. Taxable accounts get a step-up basis, as of the day of death.

What part isn't true? Let's say OP is able to either convert or withdraw all of the $2M in the 401K, and it goes up 50% before their death. Both accounts are now $3M.

If OP was converted it to a Roth the heirs have to withdraw it (move to a taxable account) within 5 (or is it 10) years with no tax hit. If they decide to move it lump sum to a taxable account, they now have a taxable account with basis of $3M.

If OP withdrew the 401K funds to a taxable account, heirs get a stepped up basis, so they new basis to the heirs is $3M.

So what part of what I said: "The beneficiary requirement is not a factor. At worst the beneficiary could take a lump sum distribution, which makes it the same as inheriting a taxable account. They could leave it to grow tax free for up to 10 years though." is not true?

 

[JustVisitingThisPlanet]

I think a backdoor Roth might be an option. It’s worth looking into, and many members here are quite knowledgeable about the details.

Yeah I was willing to take the hit of Roth conversions last few years while working and then after retired, converted just enough Roth to stay in lower tax bracket. I've also converted to Self-Directed IRA (Roth and Tradtional), allowing broader opportunity (am in private equity now).