To 401K Or Not To 401K, That Is The Question

[Vincenzo Corleone]

I'm currently retired and 52 years old. DW plans to retire in a minimum of three years and will turn 54 in a few months.

We're struggling to determine whether it would be beneficial for her to stop contributing to her 401k ($25,000 - no employer match) so that we can instead add the money to our taxable accounts. We're currently in the 22% tax bracket.

When trying to figure it out, we think we'll need to take into account:
- RMDs on the tax sheltered accounts at 70.5
- taxes
- having that tax sheltered money inaccessible for another five years (from current date)
- that the next 10 years of market returns will likely be lower than what we've experienced
- Social Security (40% of expenses after taking a 50% SS cut - collecting at 70)
- her pension (27% of expenses)
- a likely very low seven-figure inheritance at some point in the future
- we could use a cash cushion in our taxable accounts upon retirement

What other data points would I need to consider to come to a more informed decision? Do you have any opinions about what to do? Thanks.

 

[Sunset]

Instead of sticking the money in a taxable account , stick it in a roth for you , and a roth for her. Based on her income you each can hit the max allowed.

Do you already have roth accounts ? (important to know)

 

[youbet]

Here's how it works......

When we were young and DW and I both contributed the max to 401k's and IRA's, we loved, loved, loved the tax savings!

Now that we're old and taking RMD's, we hate, hate, hate being pushed into higher tax brackets, paying IRMAA, paying the extra 3.8% investment tax, having all of our SS taxed, etc.

Unless you can predict future tax brackets and high income "tax adders" and your income, it can be a tough job to figure it out. If you have significant pre-tax money already, I'd just contribute enough to the 401k to get the match.

Good luck, and enjoy that inheritance. And, btw, since there is a huge difference between a $1MM inheritance and a $9.9MM inheritance (both 7 figures), knowing what you're figuring on along those lines could determine the answer to your question. Just saying "7 figures" isn't all that helpful. It's a big range.

 

[Vincenzo Corleone]

Instead of sticking the money in a taxable account , stick it in a roth for you , and a roth for her. Based on her income you each can hit the max allowed.

Do you already have roth accounts ? (important to know)

We both already have roth accounts. Since it is (I think) widely accepted that it's best to withdraw from roth accounts last, that money could be tied up for quite a while.

 

[Big_Hitter]

- having that tax sheltered money inaccessible for another five years (from current date)

does the plan allow payments prior to 59.5 on account of "retirement" after 55?

mine does

 

[Big_Hitter]

also, does the 401k have a "stable" value fund? You can't get returns like that outside of an institutional fund, normally

 

[Vincenzo Corleone]

Now that we're old and taking RMD's, we hate, hate, hate being pushed into higher tax brackets, paying IRMAA, paying the extra 3.8% investment tax, having all of our SS taxed, etc.

That's EXACTLY what we're thinking.

Unless you can predict future tax brackets and high income "tax adders" and your income, it can be a tough job to figure it out. If you have significant pre-tax money already, I'd just contribute enough to the 401k to get the match.

There's no match on the 401K contributions. Nada.

Good luck, and enjoy that inheritance. And, btw, since there is a huge difference between a $1MM inheritance and a $9.9MM inheritance (both 7 figures), knowing what you're figuring on along those lines could determine the answer to your question. Just saying "7 figures" isn't all that helpful. It's a big range.

Very low seven-figures. Updated my OP. Thanks.

 

[Sunset]

I missed the counting chickens before they hatch part of the inheritance.. Wonder if this has something to do with the young age of retirement for OP ?

Unless of course he already has $2+ Million saved, in which case missing the inheritance due to black swan event will not be a problem.

 

[Vincenzo Corleone]

I missed the counting chickens before they hatch part of the inheritance.. Wonder if this has something to do with the young age of retirement for OP ?

Unless of course he already has $2+ Million saved, in which case missing the inheritance due to black swan event will not be a problem.

Not sure what you're getting at. The inheritance has no bearing on our ability to retire.

 

[Sunset]

We both already have roth accounts. Since it is (I think) widely accepted that it's best to withdraw from roth accounts last, that money could be tied up for quite a while.

Classic thought yes if you retire at 65, but if you weren't contributing to them at all, then filling them to spend later is better than not filling them and putting the money into a bank account (where the interest is taxed).

If you are already stuffing them, then continue doing that, and invest in outside regular CD ladders (as you don't want the market to tank, just as you need the cash).

 

[Sunset]

Not sure what you're getting at. The inheritance has no bearing on our ability to retire.

That is what I was getting at. Due to having seen a relative plan their life on some event, and then be disappointed when it does not happen and they don't get the big inheritance they thought they would get.

 

[USGrant1962]

If you are going to be managing MAGI for ACA the money in taxable accounts is gold until you are on Medicare.

 

[youbet]

That is what I was getting at. Due to having seen a relative plan their life on some event, and then be disappointed when it does not happen and they don't get the big inheritance they thought they would get.

Not to speak for Vincenzo, but based on this and earlier threads, his inclusion of likely inheritance info involves not his ability to retire, but rather the tax implications (along with the RMD's his pre-tax savings will generate) of the investment earnings of the significant inheritance.

It's smart to look at that and allow it to be a factor.

 

[bada bing]

You might check if DW's 401k allows "mega-backdoor Roth" conversions.
Most don't but a significant minority do. If it is allowed, you would have
the ability to funnel up to $61K per year into a Roth IRA, depending on
not using any qualified pre-tax contributions.

I've been moving about $40K per year for the last 5 years from taxable
thru mega-backdoor to Roth. I wish I knew about the strategy earlier.

Moving after-tax regular savings into Roth is a no-brainer if you can
do it without incurring any extra taxes.

 

[Vincenzo Corleone]

Hm...I know how many (most?) people here feel about financial advisors, but maybe this question warrants one?

 

[RetiredAt55.5]

If you are going to be managing MAGI for ACA the money in taxable accounts is gold until you are on Medicare.

True, but if the OP puts $ in a Roth IRA, the contribution portion can be withdrawn tax free at any time (if the account has been open at least 5 years).

So, there's flexibility to manage MAGI with Roth withdrawals if needed. And if you decide not to tap it for ACA purposes, it's growing tax free.

The issue with deciding on contributing to a Roth is that we you to do it while you or a spouse has earned income.


Edited: I guess this is a moot point if the OP is already maxing out their Roth IRAs.

 

[Animorph]

Definitely see if you can make 401k withdrawals after retiring at 55.

I'd go for 401k contributions now and Roth conversions later if it looks like you will have a few years of low income after retirement and sufficient taxable funds. That gets you a tax deduction while your income is (presumably) high and gets it into a Roth at a lower tax rate after you retire. Better than a Roth contribution now, if that's the situation. That's what we're doing, with essentially no income for 10-15 years after retiring while waiting for RMD's and SS at 70+.

If your taxable funds are low, then you need to accumulate enough to bridge to 59.5 for 401k/IRA withdrawals.

 

[pb4uski]

.... We're struggling to determine whether it would be beneficial for her to stop contributing to her 401k ($25,000 - no employer match) so that we can instead add the money to our taxable accounts. We're currently in the 22% tax bracket.....

If there is no match, then there is really only one good reason to continue contributing to the 401k... if your tax rate in retirement will be less than 22%... ie: 12% or less. If your tax rate in retirement will be 22% or more then it is a wash.

Tax-deferred accounts are a tax arbitrage play... that's all. So unless at some point you expect that you will have withdrawn or converted your entire 401k at lower tax rates, I would think that taxable would be preferable. Equities in a taxable account enjoy preferential tax rates on qualified dividends and long-term capital gains and the foreign tax credit on foreign taxes paid on international equities. Or muni bonds are tax-free.

 

[Vincenzo Corleone]

If there is no match, then there is really only one good reason to continue contributing to the 401k... if your tax rate in retirement will be less than 22%... ie: 12% or less. If your tax rate in retirement will be 22% or more then it is a wash.

Tax-deferred accounts are a tax arbitrage play... that's all. So unless at some point you expect that you will have withdrawn or converted your entire 401k at lower tax rates, I would think that taxable would be preferable. Equities in a taxable account enjoy preferential tax rates on qualified dividends and long-term capital gains and the foreign tax credit on foreign taxes paid on international equities. Or muni bonds are tax-free.

Thanks. So if I'm figuring things correctly, at 70, when we have to take RMDs and when we plan to collect SS, and considering DW's pension, we'll remain in the 22% tax bracket. So, assuming tax brackets remain the same in retirement, we'll be taxed on what would be her contributions at 22% either now (if DW stops contributing to her 401k) or later (if DW continues contributing to her 401k). Difference is any growth on it will be taxed at a lower 15% in a taxable account (assuming qualified dividends and long-term cap gains), whereas ALL of it will be taxed at 22% in a tax-sheltered account when we withdraw. And since market returns for the next 10 years or so are widely accepted to be disappointing, it's pretty much a wash. But in a tax-sheltered account, it would be "locked up" for a time whereas in a taxable account, we can get at it immediately if needed.

Whew! I hope I have that right.

 

[pb4uski]

You got it. From what you describe, I would go taxable.