Tax avoidance strategies for withdrawal from large 401k?

[Alan]

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).

Exactly, thanks for pointing that out.

 

[ut2sua]

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

CardsFan, could you elaborate a bit more? What does the step-up basis mean to folks who inherit these taxable accounts in terms of taxation?

 

[RetireBy90]

OP, also to consider, when you or DW pass and one is left, tax rates will jump due to filing as a single not married. If you convert today the survivor can take needed income from the Roth tax free.

 

[TonyClifton]

The DW and I opened Roth IRAs at Charles Schwab years ago. I just did one of those online chat things with a Schwab rep and she stated I just need to create a rollover IRA into which the non-Schwab 401k funds will be deposited and then they can be transferred into the Roth IRA from there.

 

[CardsFan]

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?

Apologies. I thought you were comparing the tIRA to after tax, not the Roth. For a Roth, you are correct.

 

[CardsFan]

CardsFan, could you elaborate a bit more? What does the step-up basis mean to folks who inherit these taxable accounts in terms of taxation?

Say you have $100k in an after tax account and $50k is cap gains. If you sold today you would pay taxes taxes on $50k. If you died today your heirs would get $100k. No taxes.

 

[TonyClifton]

So let's see if I have this straight: I can move funds from my work 401k or my previous employer 401k into a rollover IRA at Schwab, and then move that money into the Schwab Roth IRA that I already have. The amount moved is treated as ordinary income the same as wages for the purpose of calculating federal tax. Then from that point on, all future withdrawals from the Roth IRA are tax free, including investment returns?

If so, it seems odd that the IRS caps the annual allowable Roth IRA contributions at such a low figure, and only for a MAGI upper limit of $193k, yet if one contributes through the "backdoor" (a conversion) there is no limit, it's simply up to the account holder to determine the amount keeping an eye on the tax brackets.

Am I seeing this correctly? I'm wondering why those without a 401k or other tax sheltered retirement account are disadvantaged compared to those who can make a rollover.

 

[RetireBy90]

So let's see if I have this straight: I can move funds from my work 401k or my previous employer 401k into a rollover IRA at Schwab, and then move that money into the Schwab Roth IRA that I already have. The amount moved is treated as ordinary income the same as wages for the purpose of calculating federal tax. Then from that point on, all future withdrawals from the Roth IRA are tax free, including investment returns?

If so, it seems odd that the IRS caps the annual allowable Roth IRA contributions at such a low figure, and only for a MAGI upper limit of $193k, yet if one contributes through the "backdoor" (a conversion) there is no limit, it's simply up to the account holder to determine the amount keeping an eye on the tax brackets.

Am I seeing this correctly? I'm wondering why those without a 401k or other tax sheltered retirement account are disadvantaged compared to those who can make a rollover.

So first, I believe you are correct about moving funds to a Roth, and provided you don’t run afoul of the minor limits your withdraws are indeed not taxed.
Then there is reasoning behind the limits. I look at it as 2 separate issues. First is getting money into a retirement account like IRA or 401K. There are various limits on how much you can contribute to IRA or 401K each year. Second issue is moving money already contributed to a non-Roth to a Roth. This is not limited by amount. It is merely managing you retirement assets in my view.
Just my take

 

[TonyClifton]

So first, I believe you are correct about moving funds to a Roth, and provided you don’t run afoul of the minor limits your withdraws are indeed not taxed.
Then there is reasoning behind the limits. I look at it as 2 separate issues. First is getting money into a retirement account like IRA or 401K. There are various limits on how much you can contribute to IRA or 401K each year. Second issue is moving money already contributed to a non-Roth to a Roth. This is not limited by amount. It is merely managing you retirement assets in my view.
Just my take

Roger that. You have pointed out something I hadn't considered, which is that no matter how big a pile you got, you were limited to creating it a few shovelsful at a time. So perhaps from the IRS's view they are fine with favorable tax treatment toward money folks have been steadily withdrawing from their paychecks for retirement. Makes sense!

 

[TonyClifton]

Doing more research, I've discovered my work's 457 plan has a Roth option. The plan administrator is ICMA-RC which provides government plans. Evidently I can choose to direct both untaxed and taxed money into the 457 plan and its Roth option, subject to yearly allowable maximums, $26k currently.

However, I see several reasons to forego creating a Roth option and instead go with moving old 401k money into the previously established Schwab Roth IRA:

1. The five year clock would start with the ICMA Roth, whereas it's not a factor with the Schwab Roth.

2. The Schwab Roth allows the purchase of individual equities and a broad range of mutual funds. The ICMA plan only offers mutual funds and is not really a trading desk.

3. The 401k to Schwab Roth conversion is not subject to annual conversion limits.

Have I got that right?

 

[ut2sua]

Say you have $100k in an after tax account and $50k is cap gains. If you sold today you would pay taxes taxes on $50k. If you died today your heirs would get $100k. No taxes.

OK. I was confused thinking about before tax accounts. Thanks CardsFan.

 

[SecondCor521]

1. The five year clock would start with the ICMA Roth, whereas it's not a factor with the Schwab Roth.

Not sure which five year clock you're referring to here, but the two IRS 5 year clocks of which I am aware are, I think, related to the first Roth you ever open in your name (so specific Roth accounts do not matter) or to the first day of the tax year in which you do conversions (and I don't think you're referring to conversions). So the above doesn't make sense to me.

 

[ownyourfuture]

Since Roth conversions are a huge part of this thread, I thought I’d ask here, instead of starting a new one.

Do Roth distributions count towards your modified adjusted gross income ?
I have a HD healthcare plan & have to watch my income very closely.

 

[SecondCor521]

Since Roth conversions are a huge part of this thread, I thought I’d ask here, instead of starting a new one.

Do Roth distributions count towards your modified adjusted gross income ?
I have a HD healthcare plan & have to watch my income very closely.

You've used two different terms: conversion in your first sentence and distributions in your second sentence.

Conversions and distributions are two different things.

Roth conversions are moving money from a traditional IRA to a Roth IRA. The amount converted adds to MAGI for the tax year in which the conversion occurred. Roth conversions generally result in an increased tax liability and affect ACA subsidies.

Roth distributions are taking money out of or withdrawing money from a Roth IRA, and generally do not add to MAGI.

 

[RetireBy90]

Doing more research, I've discovered my work's 457 plan has a Roth option. The plan administrator is ICMA-RC which provides government plans. Evidently I can choose to direct both untaxed and taxed money into the 457 plan and its Roth option, subject to yearly allowable maximums, $26k currently.

However, I see several reasons to forego creating a Roth option and instead go with moving old 401k money into the previously established Schwab Roth IRA:

1. The five year clock would start with the ICMA Roth, whereas it's not a factor with the Schwab Roth.
I believe a previous post stated the 5 years are for first Roth.
2. The Schwab Roth allows the purchase of individual equities and a broad range of mutual funds. The ICMA plan only offers mutual funds and is not really a trading desk.One reason I moved my 401K to my Fidelity IRA

3. The 401k to Schwab Roth conversion is not subject to annual conversion limits.I believe you would need to verify with the plan administrator. My old 401K didn’t allow conversions, again a reason I moved the funds to my IRA

Have I got that right?

See Bold Above, I would think best option is to move to a Schwab IRA then start conversions. Just my humble opinion.

 

[ownyourfuture]

You've used two different terms: conversion in your first sentence and distributions in your second sentence.

Seriously ?
I asked exactly one question:
Do Roth distributions count towards your modified adjusted gross income ?

 

[SecondCor521]

Seriously ?
I asked exactly one question:
Do Roth distributions count towards your modified adjusted gross income ?

Yes, seriously.

I answered the literal question you asked in the last sentence in my previous post.

But I also answered a different question that you didn't ask but you may have meant to ask, given that you used two different terms in your earlier post.

I'll stop trying to help you now.

 

[RunningBum]

Since Roth conversions are a huge part of this thread, I thought I’d ask here, instead of starting a new one.

Do Roth distributions count towards your modified adjusted gross income ?
I have a HD healthcare plan & have to watch my income very closely.

Seriously ?
I asked exactly one question:
Do Roth distributions count towards your modified adjusted gross income ?

Seriously? Paraphrasing your post:
"Since Roth conversions are a huge part of this thread, I thought I'd ask a totally unrelated question here, instead of starting a new one."

Start your own thread next time.

 

[rkser]

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.

I understand you Roth converted your Non Deductible part of your IRA & paid taxes on the gains.

How did you calculate the gains on the non deductible portion in a co mingled IRA. ? Any Special Forms to complete at the Tax Time.?

Thanks in advance

 

[TonyClifton]

I see good people on both sides. (mops brow)

OK, so what I'm reading is the very first Roth IRA you open, that starts the clock for that account and any future Roth IRA accounts? Sounds good to me.

Me and my DW both have old 401k accounts of $300k each, a Fidelity and a "Merrill," and we each have older Schwab Roth IRA accounts so those are the subject of conversion.

This new wrinkle I learned today is that I can contribute to a work Roth IRA which is just added to the other conversions for tax purposes annually so I guess the decision is, is there any benefit to opening up a Roth IRA account at work and make contributions to it when I'm just gonna convert all that money to the Schwab Roth IRA eventually?

 

[Out-to-Lunch]

This new wrinkle I learned today is that I can contribute to a work Roth IRA

Here, you mean Roth 457, right? There is no such thing as a "work Roth IRA."

which is just added to the other conversions for tax purposes annually

I don't know what you mean by this. By "added to the other conversions for tax purposes" do you mean that you need to pay tax on the income that you are directing to the Roth 457? If so, yes, you need to pay tax on those funds.

so I guess the decision is, is there any benefit to opening up a Roth IRA account at work and make contributions to it when I'm just gonna convert all that money to the Schwab Roth IRA eventually?

Assuming I understood the earlier stuff correctly, everything depends on your tax rates vs. time. To first order, Roth contribution and conversion is driven by tax-rate arbitrage. (There are smaller higher-order effects, too.) So the answer to your last question mostly depends on the tax rate in the year of contribution (to the Roth 457) compared to a future (?) time when you would either convert or withdraw from a pretax account.

I think I see what you are getting at though. I believe you have some ability to save some more money, shortly before retiring, and trying to figure out the best vehicle, given being so close, and also planning Roth conversions later, right?

I am in a not-so-dissimilar situation. Rightly or wrongly, I decided to not contribute to the Roth 4XX, and instead bank cash for a couple years before pulling the plug. I will use this cash to pay taxes on conversions from an TIRA to a Roth. The net result is about the same as contributing to a Roth 457 (or 401k or 403b), minus about 1 or 2 years of tax on gains and plus some much-desired liquidity.

 

[Alan]

I understand you Roth converted your Non Deductible part of your IRA & paid taxes on the gains.

How did you calculate the gains on the non deductible portion in a co mingled IRA. ? Any Special Forms to complete at the Tax Time.?

Thanks in advance

Nothing was co mingled. The year I retired (March 2nd) was a low income year and I only had 1 IRA which was a non-deductible IRA so it is very easy to see the taxable portion. I converted the entire IRA leaving only a Roth in my account.

The following year I rolled over my very much larger 401k into an IRA. Now I had 1 Rollover IRA in my account that was 100% taxable. If I had not waited until the following year then I would have had co-mingled IRAs and it is not possible to selectively convert as any conversion looks at the cost basis of all IRAs and only a small portion of the non-deductible gets converted. In that case IRS form 8606? needs to be completed and that calculates the basis going forward for future tax years.

 

[rkser]

OK, I understood, thanks for your reply Alan,

In my case Deductible & Non deductible Funds are co mingled in my IRA, so when I Roth convert, I pay taxes on the deductible (Pre Tax monies) portion of the conversion funds & file Form 8606 for that year.

I wish I had kept the IRAs separate, one for Deductible & one for Non deductible funds, smart planning & foresight Alan!!

 

[Alan]

OK, I understood, thanks for your reply Alan,

In my case Deductible & Non deductible Funds are co mingled in my IRA, so when I Roth convert, I pay taxes on the deductible (Pre Tax monies) portion of the conversion funds & file Form 8606 for that year.

I wish I had kept the IRAs separate, one for Deductible & one for Non deductible funds, smart planning & foresight Alan!!

Everything I learned about the mechanics of Roth conversions I learned here. My thanks goes to the collective wisdom of this site.

 

[PhrugalPhan]

I see good people on both sides. (mops brow)

OK, so what I'm reading is the very first Roth IRA you open, that starts the clock for that account and any future Roth IRA accounts? Sounds good to me.

Me and my DW both have old 401k accounts of $300k each, a Fidelity and a "Merrill," and we each have older Schwab Roth IRA accounts so those are the subject of conversion.

This new wrinkle I learned today is that I can contribute to a work Roth IRA which is just added to the other conversions for tax purposes annually so I guess the decision is, is there any benefit to opening up a Roth IRA account at work and make contributions to it when I'm just gonna convert all that money to the Schwab Roth IRA eventually?

As a participant in a 457 plan, here is my take on this.

The advantages to doing Roth in your 457 is:

1) There is no $7000 contribution limit like with a Roth (or traditional) IRA

2) If you think you will have plenty of low tax space to convert when you retire, then doing Roth now isn't a major need. However, if you have a pension (like I do) it is very possible you will be stuck with as high or higher tax rates once you have SS & pension coming in. (I worked out an estimate and I am in this situation) Due to that I am almost exclusively contributing to Roth 457 at this time as I expect tax rates to rise in the future.

3) There is a rule that 457 plans *can* have a 3 year catch up rule. That is if you are within 3 years of your pension plan's retirement age, you can contribute up to 200% of the normal contribution limit for 3 years. My plan has this option and I started using it this year. I have already contributed $22k as Roth money this year and will do around $36k this year when its all said and done. If this interests you, check with your HR or plan administrator to see if this option exists for you.

4) My plan also allows for in plan Roth conversions. If you want to convert now before you retire, check with your HR to see if this option exists. Our plan added it two years ago, and I did a small conversion this April during the meltdown. I wish I had done a larger amount, but oh well....

And here is a possible disadvantage:

5) Check to see if your plan allows you to indicate what type of contributions you withdraw, or if you are forced to do so proportionally. My plan originally forced you to withdraw proportionally between pre and post tax (which would have been a problem). That rule was removed a few years ago, now I can pull out whatever type of money I want.