401K Withdrawal instead of Roth converting?

[cat4ever]

Situation: 57 and use rule of 55 for penalty free withdrawal from 401K for all our spending money, about $160K/year, not including college costs covered by 529 funds.
2 kids in college funded via 529 funds.
Currently on COBRA until August 2022, so IRMAA not an issue until then.

Question: Would it make any sense to simply withdraw (instead of Roth convert) 401K funds this year well into the 24% bracket in order to keep my income low in subsequent years in order to qualify for IRMAA and possibly FAFSA? I'm not asking for specific numbers, calculators etc as I don't trust my ability to use such tools correctly, nor my guesses as what the future might bring. I'm just asking if it might be somewhat sensible, or really dumb?

Since I'll be on COBRA for 7 months in 2022, would it make sense to do the same next year as well?

Thanks

 

[RetiredHappy]

You probably meant not hit with IRMAA instead of "qualify for IRMAA". Without giving us the actual number that you are working with, you have to do your own Math as to whether it is worthwhile to do Roth conversion or not. Each person's situation is different.

What are your ages when your kids apply to college? What income is being generated by your taxable accounts? You are already withdrawing $160K/yr from 401K which makes me think that you don't have alot of room in taxable accounts. If you need to pull out more now for future years expenses to avoid the need to report higher income for living expenses then, you probably should do so. However, you are also going to lose tax deferred growth of that money.

 

[pb4uski]

You don't have to worry about IRMAA for about another 7 years... it would not come into play until you are on Medicare and then it would look at your tax return two years prior to your going on Medicare.

And before fretting about FASFA, go through a calculator and see if you even have a prayer of getting anything even to begin with... I know that we didn't but I was working and we had a six-figure income at the time DD was applying to colleges.

 

[cat4ever]

Sorry that I used the wrong term. When I said IRMAA, I meant whatever the line is for receiving subsidies on the Obamacare exchange.

 

[sengsational]

I'm confused about the question. Pulling 401k funds will add to MAGI, and you'd have that money to spend. Roth converting would add to MAGI and you would not have that money to spend.

Is your after tax savings balance significant? If it would cover your expenses for many years, then FAFSA benefits might be hard to get. If your after tax savings/investments are negligible, then FAFSA is in play and you would pull from traditional 401k up to an advantageous level, and pull from Roth to get to your required spend level.

 

[pb4uski]

Sorry that I used the wrong term. When I said IRMAA, I meant whatever the line is for receiving subsidies on the Obamacare exchange.

Oh, ACA subsidies?

What you can do is using something like TurboTax What-If Worksheet is to look at the net tax (net of ACA subsidies) of large withdrawals in 2021 and lower withdrawals in 2022-2024 vs level withdrawals. Look at the combination of the tax cost (incuding state income taxes if appicable and ACA subsidies).

I seem to recall some posters suggesting that the cost of lost ACA subsidies is around 8.5% but you shoudl do your own calculations since it could vary based on individual facts and circumstances.

 

[cat4ever]

yes, ACA subsidies. So it really becomes a battle between increasing ACA subsidies which will be very much in play for me for the next 6-7 years vs doing Roth conversions, I think. (forget FAFSA, that ones way to complicated to figure out). ie. does it make any sense to set myself up for increased subsidies in the future by taking the tax hit this year and next when I'm going to be on COBRA for all or part of the year. btw, I am able to use Health Saving Account funds (i.e. tax free) to pay for my COBRA, which won't be the case for ACA.

 

[Doingitwrong]

From the same 401K?
Aren't you locked into the method you used originally to calculate your Substantially Equal Periodic Payment?

 

[HenryD]

From the same 401K?
Aren't you locked into the method you used originally to calculate your Substantially Equal Periodic Payment?

OP said they are using Rule of 55, not 72T.

 

[Doingitwrong]

OP said they are using Rule of 55, not 72T.

Thanks. Googled. I left 55 behind.

 

[jazz4cash]

The way I read your question….Yes, taking a 401k withdrawal (distribution) now can smooth out recognition of income in the same manner as making Roth conversions. Smoothing out recognition of income could keep you from exceeding some of the trigger levels for ACA, IRMA, tax brackets, etc. The first step in a Roth conversion is taking a distribution and paying the taxes. The additional benefit of Roth is never paying taxes on gains is more attractive for assets that appreciate like stocks. If you don’t use Roth capital gains treatment can still be attractive.

 

[cat4ever]

The way I read your question….Yes, taking a 401k withdrawal (distribution) now can smooth out recognition of income in the same manner as making Roth conversions.

The drawback of doing a Roth is I have to wait 5 years to use any of the money, even the "principle" since it's a conversion, not a deposit from already taxed money. If I have to wait 5 years to use it, most of my ACA years will have already gone by.

 

[cat4ever]

Oh, ACA subsidies?

I seem to recall some posters suggesting that the cost of lost ACA subsidies is around 8.5% but you shoudl do your own calculations since it could vary based on individual facts and circumstances.

My understanding is above about $70000 in income, your ACA premium won't be more than 8.5% of your reported income (so gradual decline in savings instead of a drop off), although I'm not sure which year's income is used. I'm also not sure what level of plan that pertains to (Gold, Silver, Bronze). Or I could be completely confused. Here's what the "trigger income level" post says:

$69,680 - 400% FPL -- ACA subsidy reduced to the point where premium can be 8.5% of income (Household of two, Lower 48)(note that ACA subsidy levels are based on the prior year’s poverty levels)

So, if I could keep ours at 100K, ACA insurance would be $8500, about half of what we're paying for COBRA.

 

[oldtimer]

The drawback of doing a Roth is I have to wait 5 years to use any of the money, even the "principle" since it's a conversion, not a deposit from already taxed money. If I have to wait 5 years to use it, most of my ACA years will have already gone by.

Assuming you turn 59.5 in 2024 and if your Roth IRA was opened in 2019 or earlier, then all your conversions this year and into the future will be 100% available once you turn 59.5 - 2.5 years from now. See this Roth distribution table for clarification.

 

[cat4ever]

Assuming you turn 59.5 in 2024 and if your Roth IRA was opened in 2019 or earlier, then all your conversions this year and into the future will be 100% available once you turn 59.5 - 2.5 years from now. See this Roth distribution table for clarification.

Well that could certainly change my calculus. I turn 59.5 on 1/31/24 so one scenario could be to just continue with the Roth's, bite the bullet for a year and a half of smaller ACA subsidies, and then start picking them up from 2023 until medicare kicks in, using my extra Roth money to keep my income low. I'll have to run the numbers through TT as suggested, but sounds like it might be 6 one 1/2 dozen the other in the end; more Roth tax free growth, vs a year of full ACA subsidies. Of course this presupposes there will be Roth growth, maybe not the best thing to assume after today's market action

btw, I also found another source for the same information here:

https://www.irahelp.com/forum-post/31165-roth-ira-conversion-after-59-12

 

[Dtail]

We have both situations.
My DGF converts to a Roth each year.
My brother (my dependent) and I go nthe route of ACA subsidies each year to the tune of 23k combined savings.
In my later 60's, I will probably switch to Roth conversions.

 

[cat4ever]

Thanks for that. So in the end it's not a crazy idea, which is mainly what I was looking for. Right now I'm thinking I'll go the route of withdrawing halfway into 24% range to cash which will set me up for either a large purchase in 2022 (car comes to mind), and/or to reducing MAGI in 2023 to get max ACA subsidies for the one year before I can access my Roth money. Beyond that who knows, my crystal ball gets cloudy very quickly, but I can make those decisions later.