What to spend first?

[pb4uski]

I'm skeptical that your employer can arbitrarily assess a 10% penalty if your plan is a 401(k) plan and you leave serveice after age 55... the IRS criteria below:

Quote:

To discourage the use of retirement funds for purposes other than normal retirement, the law imposes a 10% additional tax on certain early distributions from certain retirement plans. The additional tax is equal to 10% of the portion of the distribution that's includible in gross income. Generally, early distributions are those you receive from a qualified retirement plan or deferred annuity contract before reaching age 59½. The term qualified retirement plan means: A qualified employee plan under section 401(a), such as a section 401(k) plan A qualified employee annuity plan under section 403(a) A tax-sheltered annuity plan under section 403(b) for employees of public schools or tax-exempt organizations, or An individual retirement account under section 408(a) or an individual retirement annuity under section 408(b) (IRAs) In general, an eligible state or local government section 457 deferred compensation plan isn't a qualified retirement plan and any distribution from such plan isn't subject to the 10% additional tax on early distributions. However, any distribution attributable to amounts the section 457 plan received in a direct transfer or rollover from one of the qualified retirement plans listed above would be subject to the 10% additional tax. Exceptions to the 10% Additional Tax Distributions that aren't taxable, such as distributions that you roll over to another qualified retirement plan, aren't subject to this 10% additional tax. For more information on rollovers, refer to Topic No. 413 and visit Do I Need to Report the Transfer or Rollover of an IRA or Retirement Plan on My Tax Return? There are certain exceptions to this 10% additional tax. The exceptions below apply to distributions from a qualified plan other than an IRA. For a complete list, look at the Appendix for Notice 2020-62PDF. Distributions made to your beneficiary or estate on or after your death. Distributions made because you're totally and permanently disabled. Distributions made as part of a series of substantially equal periodic payments over your life expectancy or the life expectancies of you and your designated beneficiary. If these distributions are from a qualified plan other than an IRA, you must separate from service with this employer before the payments begin for this exception to apply. Distributions to the extent you have deductible medical expenses that exceed 7.5% of your adjusted gross income whether or not you itemize your deductions for the year. For more information on medical expenses, refer to Topic No. 502. Distributions made due to an IRS levy of the plan under section 6331. Distributions that are qualified reservist distributions. Generally, these are distributions made to individuals called to active duty for at least 180 days after September 11, 2001. Distributions that are excepted from the additional income tax by federal legislation relating to certain emergencies and disasters. Distributions up to $5,000 made to you from a defined contribution plan if the distribution is a qualified birth or adoption distribution. Distributions made to you after you separated from service with your employer if the separation occurred in or after the year you reached age 55, or distributions made from a qualified governmental benefit plan, as defined in section 414(d) if you were a qualified public safety employee (federal state or local government) who separated from service in or after the year you reached age 50. Distributions made to an alternate payee under a qualified domestic relations order. Distributions of dividends from employee stock ownership plans.

(emphasis added). https://www.irs.gov/taxtopics/tc558

Check with your tax advisor.

[Beachbound]

Thank you- the 10% penalty I referred to would be from the IRS since no “rule of 55” from employer. And yes, loans are available from 401k, but would have to be paid in full upon leaving, so no help there.

Spouse does have a smaller 401k- about 130k, and is 1 year older. So could take that when they reach 59 1/2 without penalty to fund another year before pension/SS.

So looking at most needed 2 large withdraws 401k that come with IRS penalty- say $20,000 if $200,000 total taken max. Not idea for sure- but not worth working another year either- or committing to a 5 year SEPP etc.

A 10 year annuity to bridge the gap also would give security, but it the long run, I could lose there using 1/2 of my 401k to set up?

House mortgage rate is just under 4%.

[MarieIG]

I had briefly considered taking monthly payments from my 401k with my former employer. The $95 fee they charged, for each and every withdrawal, tipped the balance in favor of an IRA rollover. The .52 % administration fee charged quarterly to the account, did not help.

Conversely, some 401k plans are great. Presumably, OP will examine his closely prior to making a determination as to whether to stay in the plan, or roll the account into an IRA.

[rmorris50]

I’m in a very similar situation where I have most of our $3m NW in pre-tax retirement accounts. So to retire early it’s hard to find a away to access enough of the money without the penalty.

But it’s worth pointing out your effective federal tax rate paying the penalty may very well be no worse than that if you continued working. I have projected out all sources of income, taxes, and expenses for the rest of my life so I can play with all kinds of scenarios of how to best access my money. In the process I’ve learned that paying the penalty of accessing pre-tax money doesn’t result in a higher effective tax rate than if I kept working and paying the tax on my income. The bigger risk is accessing too much money too early and the plan imploding later in retirement.

So yes naturally we all want to avoid the penalty but really the penalty is about us not getting the tax arbitrage if we retire early.

Also, I’ve found if I just leave my pre-tax untouched until RMDs kick in, I’m getting kicked into the higher marginal tax brackets and will pay an effective tax rate similar to that when I was working!

So given all that, generally speaking I plan to use pre-tax money first in combination with after tax savings, and leave Roth type money for last. Even if it means paying the penalty here and there. Of course I’ll try to avoid that or minimize that.

[Beachbound]

Quote:

Originally Posted by rmorris50 I’m in a very similar situation where I have most of our $3m NW in pre-tax retirement accounts. So to retire early it’s hard to find a away to access enough of the money without the penalty. But it’s worth pointing out your effective federal tax rate paying the penalty may very well be no worse than that if you continued working. I have projected out all sources of income, taxes, and expenses for the rest of my life so I can play with all kinds of scenarios of how to best access my money. In the process I’ve learned that paying the penalty of accessing pre-tax money doesn’t result in a higher effective tax rate than if I kept working and paying the tax on my income. The bigger risk is accessing too much money too early and the plan imploding later in retirement. So yes naturally we all want to avoid the penalty but really the penalty is about us not getting the tax arbitrage if we retire early. Also, I’ve found if I just leave my pre-tax untouched until RMDs kick in, I’m getting kicked into the higher marginal tax brackets and will pay an effective tax rate similar to that when I was working! So given all that, generally speaking I plan to use pre-tax money first in combination with after tax savings, and leave Roth type money for last. Even if it means paying the penalty here and there. Of course I’ll try to avoid that or minimize that.

Yes- thank you. The tax man will get us all one way or another- but trying to make it the minimal is the goal for all. My payroll checks now have over 45-50% deductions between taxes, contributions, insurance. It’s surprising when I do look at my take home pay-how different that is from my salary. What I make, and what I take home and live on are 2 different figures for sure. Some stays- but rates will be much lower than what I pay now working.

[SecondCor521]

Quote:

Originally Posted by Beachbound Thank you- the 10% penalty I referred to would be from the IRS since no “rule of 55” from employer.

No, it wouldn't.

The 1099-R from your employer may indicate that a 10% penalty may be due. If you qualify under the federal law, then you may use IRS Form 5329 line 1 exception code 1 to avoid the 10% penalty.

From the IRS:

"Exceptions to the Additional Tax on Early Distributions

[Exception 01] Qualified retirement plan distributions (doesn’t apply to IRAs) you receive after separation from service when the separation from service occurs in or after the year you reach age 55 (age 50 for qualified public safety employees). For distributions to qualified public safety employees on or after December 30, 2022, include distributions to employees with 25 years of service with the plan, distributions to firefighters covered by private sector retirement plans, and distributions to those employees who provide services as a corrections officer or as a forensic security employee, providing for the care, custody, and control of forensic patients, who meet the age requirement above."

-- page 4 column 2 at https://www.irs.gov/pub/irs-pdf/i5329.pdf

[Emphasis added.]

[Beachbound]

Quote:

Originally Posted by SecondCor521 No, it wouldn't. The 1099-R from your employer may indicate that a 10% penalty may be due. If you qualify under the federal law, then you may use IRS Form 5329 line 1 exception code 1 to avoid the 10% penalty. From the IRS: "Exceptions to the Additional Tax on Early Distributions [Exception 01] Qualified retirement plan distributions (doesn’t apply to IRAs) you receive after separation from service when the separation from service occurs in or after the year you reach age 55 (age 50 for qualified public safety employees). For distributions to qualified public safety employees on or after December 30, 2022, include distributions to employees with 25 years of service with the plan, distributions to firefighters covered by private sector retirement plans, and distributions to those employees who provide services as a corrections officer or as a forensic security employee, providing for the care, custody, and control of forensic patients, who meet the age requirement above." -- page 4 column 2 at https://www.irs.gov/pub/irs-pdf/i5329.pdf [Emphasis added.]

OK- so even if the employer doesn’t participate in the rule of 55, it is a federal exception since I retired from the company at age 55. My job is nothing is public service. So my company may impose the 10% penalty during my withdrawal, but that would be credited back during my tax filing because I meet the federal requirements?

Same way the company would impose a 22% federal tax, but after filing and with my income, deductions, etc.that tax rate would be much lower than 22%.

Great information- thank you again!

[Gumby]

I think what some have been saying is that the company may not let you have periodic distributions, may limit you to a certain amount and/or may charge a fee for them. As an example, the young wife has a 457 account left from her days as a teacher. She can only take 10% of the balance once a year, and there is a fee to do it. If she wants more than 10%, she has to take it all, which would present a huge tax bill (even without a 10% early withdrawal penalty from the IRS). We have not needed to touch any of it for the last 4 years since we retired, so it hasn't been a big deal for us, but very soon we are going to roll it into a tIRA at Vanguard (trustee to trustee transfer) just to have more control, better investment choices and less fees going forward.

[Beachbound]

Quote:

Originally Posted by Gumby I think what some have been saying is that the company may not let you have periodic distributions, may limit you to a certain amount and/or may charge a fee for them. As an example, the young wife has a 457 account left from her days as a teacher. She can only take 10% of the balance once a year, and there is a fee to do it. If she wants more than 10%, she has to take it all, which would present a huge tax bill (even without a 10% early withdrawal penalty from the IRS). We have not needed to touch any of it for the last 4 years since we retired, so it hasn't been a big deal for us, but very soon we are going to roll it into a tIRA at Vanguard (trustee to trustee transfer) just to have more control, better investment choices and less fees going forward.

Thanks Gumby- definitely need to do some more research on my end, but from what I have discussed with them before- there are no set limits on what I can withdrawal after I separate from company-but highly taxed for sure. I know I won’t need any large amounts for the first 2-3 years, but will have to make some withdrawals before 59 1/2 for sure. Just need to figure out how much cash to use initially and how much to supplement with withdrawals each year- or wait for withdrawals until absolutely needed.

[rmorris50]

Quote:

Originally Posted by pb4uski I think you have enough to retire but not by a long shot based on what you have written. The bigger problem is penalty-free access to your 401k money from ER at 55 to 59-1/2. You'll need to do a cash flow schedule to see if you can cover 55 to 59-1/2. If you can't or it is uncomfortabley close, then you might consider a cash out refinancing or HELOC to get you from 55 to 59-1/2. What is your current home mortgage interest rate? Another alternative to solve the liquidity problem would be to roll the 401k into an tIRA and then do a SEPP/72t. Des your employer allow partial withdrawals from your 401k? Does it allow 401k loans? If so, are 401k loans required to be repaid when you leave? Can you downshift to part -time?

My HELOC rate right now is 9.5%!!! Just might as well pay the penalty [emoji15].

[Gumby]

Quote:

Originally Posted by Beachbound ... - health insurance would come from ACA beginning 2024, so yes, would like to keep my income as low as possible for subsidies. ....

Don't go overboard with this. To qualify for the ACA at all, your adjusted gross income needs to be above the Federal Poverty Line (FPL). For a non-Medicaid expansion state like Florida, that is $18,310 per year for a household of two (as of 2023). The system is set up assuming that you will be on Medicaid if your income is below that, but Medicaid also has an asset test, which you probably will not be able to meet. So you may find yourself with no health insurance at all other than full pay private insurance. Even in the early years, when you still have after tax savings, you'll still want to pull at least this much from your 401k or tIRA.

[NW-Bound]

To get access to your pre-tax money in your 401k without penalty, you can roll it out to an IRA.

Then, you don't have to pay the 10% penalty on your withdrawals prior to 59-1/2 by doing a 72(t) distribution.

The rules regarding 72(t) are very rigid. There are a few different ways the distribution can be scheduled, but once a method is chosen it generally cannot be changed. So, one has to do a lot of planning.

PS. I am fortunate to have sufficient after-tax money to tide me over till 59-1/2, so did not have to do 72(t) distribution.

If I had to do 72(t), I would schedule a bit more withdrawal than my planned expenses, to build up a cash buffer for large unexpected expenses. I would also start distribution early, in order to not spend down my after-tax money too much.

[Gumby]

Quote:

Originally Posted by NW-Bound To get access to your pre-tax money in your 401k without penalty, you can roll it out to an IRA. Then, you don't have to pay the 10% penalty on your withdrawals prior to 59-1/2 by doing a 72(t) distribution. The rules regarding 72(t) are very rigid. There are a few different ways the distribution can be scheduled, but once a method is chosen it generally cannot be changed. So, one has to do a lot of planning. PS. I am fortunate to have sufficient after-tax money to tide me over till 59-1/2, so did not have to do 72(t) distribution. If I had to do 72(t), I would schedule a bit more withdrawal than my planned expenses, to build up a cash buffer for large unexpected expenses. I would also start distribution early, in order to not spend down my after-tax money too much.

I don't want to speak for the OP, but it seems he wants to leave the money in his 401k because he thinks he'll be able to get more money out penalty free than the 72(t) will permit and the 72(t) amount is insufficient to cover his living expenses, even when supplemented by after tax savings. A brief look at this calculator https://www.bankrate.com/retirement/...on-calculator/ shows about $47k allowable without penalty. If his living expense are truly $120k and his after tax savings is only $60k, he won't even make it one year.

[NW-Bound]

^^^ Thanks. I missed the pertinent facts in the OP's post.

Sorry.

I will go back to sleep now.


PS. But before I do that, I have to say I agree with earlier posters about being able to take money out of a 401k if you leave work after 55. I did not have that option as I left megacorp at the age of 40.

[pb4uski]

I think the OP can use a higher rate and his 72t could be as much as $63k a year using 4.99%, 120% of the April 2023 mid-term Applicable Federal Rate assuming $1 million 401k and OP is 55 and spouse is 54.

Quote:

Your maximum annual 72(t) distribution is $62,787. Your maximum 72(t) distribution of $62,787 per year was calculated by the 'Fixed annuitization method' method at 4.99%. To avoid penalties, payments must last for five years (the five-year period does not end until the fifth anniversary of the first distribution received) or until you are 59-1/2, whichever is longer.

[SecondCor521]

Quote:

Originally Posted by Beachbound OK- so even if the employer doesn’t participate in the rule of 55, it is a federal exception since I retired from the company at age 55. My job is nothing is public service. So my company may impose the 10% penalty during my withdrawal, but that would be credited back during my tax filing because I meet the federal requirements? Same way the company would impose a 22% federal tax, but after filing and with my income, deductions, etc.that tax rate would be much lower than 22%. Great information- thank you again!

You're welcome.

It's likely even better than what you said. Your employer will not impose the 10% early withdrawal penalty. I've never heard of that happening, and from what I understand it should not happen.

You also may be able to tell the company what withholding rate you want for federal and any applicable state taxes. Ask your 401(k) administrator.

Quote:

Originally Posted by Gumby The system is set up assuming that you will be on Medicaid if your income is below that, but Medicaid also has an asset test, which you probably will not be able to meet.

In my state, which expanded Medicaid, there is no asset test. I don't know how that interacts with asset tests for things like Medicaid long term care, or for seniors.