Partial Rule of 55 and other options?

[tulak]

I found out that I'm unable to use Rule of 55, or more specifically, get partial distributions from my 401k if I leave in the year I'm 55+. I'll be 55 in 2028.

I'm looking for advice on solutions to get me to 59.5. Most of my assets are in tax deferred/sheltered accounts. For the sake of this post, let's assume that I'm solely dependent on tax deferred or sheltered accounts.

Let's say I need 100k/year, so I'd need 500k total.

My 401k allows me to split a lump-sum distribution between me and a rollover IRA after separation of service. This allows me to take a one-time distribution from my 401k where I can claim an exception for an early distribution.

Using the one-time distribution from my 401k, I'll take up to the (current) 24% bracket (single), which is 197.3k, but lets round up to 200k to keep it simple. This gives me 2 years of income (ignoring the tax hit).

For the other 3 years, I will take out my principal contributions from my Roth IRA. I should have enough contributions to my Roth for the additional 300k (thank you Mega-Backdoor Roth). My plan here is that I would take a 100k of principal contribution from the Roth IRA, and at the same time, I would rollover 100k from my tax-deferred accounts to the Roth IRA, maintaining the balance in my Roth IRA while drawing down my tax-deferred accounts.

Those are the two options that I'm thinking of using. I'm also thinking using the principal Roth IRA contributions first, possibly rolling over more than the 100k a year, up the current 24% bracket, before I do the 401k lump-sum rollover. Of course this depends on the future tax rates. It might also allow me to skip the lump-sum distribution from the 401k, but I want to maintain that as an option if necessary.

I could look at doing a 72t, but I would prefer to avoid that if I can.

Any other ideas? Does anyone see any problems with this approach?

 

[mrfeh]

Haven't run the numbers, but a couple thoughts occur:

• you can't "ignore the tax hit"; your effective rate would be 18.6% on the 401K distribution
• you're gonna owe taxes on rollovers to your Roth; assuming those taxes come from the withdrawal, you won't be "maintaining the balance in my Roth IRA"

 

[Al18]

I would not take any money from the Roth IRA. You are still working and will work another 3 years. Reduce the amount you are contributing to a 401K and instead invest in stock funds and CD’s in a brokerage account, so you can spend this money penalty free in early retirement.

 

[sengsational]

You might sharpen your pencil on the half million. Split out the taxes and work-related expenses (daily commute, etc). This is your monthly burn rate. Don't include savings or investments. This includes "out the door" things only, and doesn't include income tax, which you model separately.

Now do a simple model. Columns with your various pre tax account balances and spending account balance. Add transactions for monthly "burn rate." When the spending account gets low, make transfer transactions and taxes expenses associated with those transfers if there's a tax effect. Use your overall tax rate, not marginal (or not 22 or 24%). As burn rate expenses drive the spending account towards zero, model another withdrawal. You can "sip" from Roth, and sip from the tIRA (the account you've created from your 401k). Or you can take a small split off of the tIRA and do a 72t. I know that's a crummy option, but you make it small enough, it can get you by without long term consequences.

You can even get a HELOC to get you to unpenalized withdrawal end zone. Or if you have a big investment in a daily commuter vehicle, sell it.

Don't keep working! You can do it!

 

[NgineER]

I think there is plenty of good advice here.

I think you should look into the details of a 72T and not get the tax hit from the one-time distribution.
You should also consider a Roth roll over ladder. It is tight for you with your level of contributions, but with the addition of some brokerage assets or t-IRA withdrawals you could do a Roth rollover.
Year 1 - roll over 100k, spend 60k from Roth contributions and 40k from t-IRA (or from brokerage as it would be more tax advantageous)
Repeat for four more years.
Year 6 - roll over 100k from tIRA - spend 100k from year 1 roll over contribution.

Not a bad idea to reduce 401k contributions and grow brokerage more.

 

[tulak]

Thanks to all that responded. This is good feedback and helps me think through the details.

Haven't run the numbers, but a couple thoughts occur:

• you can't "ignore the tax hit"; your effective rate would be 18.6% on the 401K distribution
• you're gonna owe taxes on rollovers to your Roth; assuming those taxes come from the withdrawal, you won't be "maintaining the balance in my Roth IRA"

I should have said the 100k includes taxes. My hope was to avoid this post as a tax topic, but maybe that's not possible. The question I'm trying to answer is, what are my options in withdrawing 500k from 55 to 60 from tax-deferred/sheltered accounts?

But let me take a look at the tax impact.

For 100k/year, the effective tax rate is 17.7%, with total tax of $17,650. At least that's what I calculated, but please let me know if I got this wrong, since it differs with your 18.6% effective rate.

My original plan was to take a 100k/year as a partial withdrawals from my 401k (Rule of 55), so in that case, I would pay $88,250 in taxes.

Now with a plan of two years from tax-deferred and three years from Roth contribution withdrawals, back-filled with Roth conversions.

For the lump-sum partial distribution, I would take 197.3k at once (up to 24% bracket), resulting in a tax of $40,198 and an effective tax rate of 20.5%.

For the Roth contribution withdrawals, there's no tax.

For the 100k Roth conversion, I'm assuming the tax would be $17,650/year. I would convert the full 100k to the Roth, while withdrawing a 100k in contributions from the Roth. I would pay the tax from the contribution withdrawal, so I would maintain the same balance in the Roth.

So for this option, I paid a total tax of $40,198 + ($17,650 * 3) = $93,148.

That's $4,898 more than I would have paid had my 401k offered Rule of 55. That doesn't seem too bad?

Of course, if I have enough contributions in the Roth IRA to take 400k, then I could do a one year distribution from the 401k for 100k, and withdraw 400k from the Roth IRA.

That should have the same tax impact if I was able to use a Rule of 55, right?

I would not take any money from the Roth IRA. You are still working and will work another 3 years. Reduce the amount you are contributing to a 401K and instead invest in stock funds and CD’s in a brokerage account, so you can spend this money penalty free in early retirement.

This is tricky. I'm in a high tax bracket right now. I haven't run the numbers - which I should do - but I'm pretty sure that reducing my taxable income from the 32/35% marginal bracket now is a better option than paying more tax now and saving in a taxable account.

Also, even if I reduced tax-deferred contributions, wouldn't it be better to redirect this to a Roth instead of a taxable account?

I can withdraw Roth contributions tax and penalty free at any time. And there's always the chance that I won't need the Roth money, so better to have it in a Roth, right?

You might sharpen your pencil on the half million. Split out the taxes and work-related expenses (daily commute, etc). This is your monthly burn rate. Don't include savings or investments. This includes "out the door" things only, and doesn't include income tax, which you model separately.

Now do a simple model. Columns with your various pre tax account balances and spending account balance. Add transactions for monthly "burn rate." When the spending account gets low, make transfer transactions and taxes expenses associated with those transfers if there's a tax effect. Use your overall tax rate, not marginal (or not 22 or 24%). As burn rate expenses drive the spending account towards zero, model another withdrawal. You can "sip" from Roth, and sip from the tIRA (the account you've created from your 401k). Or you can take a small split off of the tIRA and do a 72t. I know that's a crummy option, but you make it small enough, it can get you by without long term consequences.

You can even get a HELOC to get you to unpenalized withdrawal end zone. Or if you have a big investment in a daily commuter vehicle, sell it.

Don't keep working! You can do it!

Yes, I need to sharpen my pencil and run the numbers.

I appreciate your point on modeling the expenses and "sipping" from accounts. I didn't think about it this way and instead was looking to make a single withdrawal at the beginning of the year and see how it goes.

As for expenses, I picked 100k/year to keep things simple. I can get by on less, which is why it's safe for me to include taxes in the 100k, but realistically, I would like to spend more. And I will have some money in taxable accounts, which I'm not including here.

But I still want (need) a bulk of the money to come from tax-deferred accounts. Another concern I have is that I need to reduce the tax-deferred accounts before RMDs hit at 73. I will likely be taking at least 100k/year until I'm 73, if not more, in order to do Roth conversions. But what I want to do is start this process at 55, not at 59.5.

And thank you for the encouragement! It is much appreciated, as is your feedback.

I think there is plenty of good advice here.

I think you should look into the details of a 72T and not get the tax hit from the one-time distribution.
You should also consider a Roth roll over ladder. It is tight for you with your level of contributions, but with the addition of some brokerage assets or t-IRA withdrawals you could do a Roth rollover.
Year 1 - roll over 100k, spend 60k from Roth contributions and 40k from t-IRA (or from brokerage as it would be more tax advantageous)
Repeat for four more years.
Year 6 - roll over 100k from tIRA - spend 100k from year 1 roll over contribution.

Not a bad idea to reduce 401k contributions and grow brokerage more.

I ran the numbers above, but the tax hit for the one-time distribution is less than 5k if I take out two years and a wash if I only take out one year. I wouldn't do more than two years (200k), since that pushes me into higher tax brackets. So I still think it makes sense for me to do a one-time partial withdrawal, right?

The Roth roll over ladder doesn't help me, since I only need a plan for 5 years to get me to 59.5. After that, I'll have full access to my tax-deferred accounts. But yes, if I was to do this before 55, I would look at this option.

I need to read up on 72T. The record keeping is a bit off-putting to me, but maybe it's not that bad?

Well, I wrote a lot, and if you read all of this, then I'm amazed and thank you.

Please let me know if any of the above doesn't make sense. It makes sense to me right now, but I could easily be missing something.

 

[pb4uski]

A one time tax hit for a large distribution doesn't seem like a good idea to me, but perhaps if you are in the 32/35% tax bracket already it doesn't seem that bad.

Using IRS & State Tax Calculator | 2005 -- 2025 single and $100k tIRA withdrawal I get 13.61% in taxes. Are you including state income taxes in your higher numbers?

If your income from work puts you in the 32/35% tax bracket then I would agree that you should continue tax deferred savings as it is better to avoid paying 32/35% now and pay less later.

I think a 72t may be the best solution for you with withdrawals of Roth conversions supplementing 72t withdrawals if necessary.

If you own real estate you might do a cash out refinancing and put the proceeds in a taxable account. That would provide liquidity for the 55-59-1/2 period and then you can deal with paying it off after you are 59-1/2. Or for that matter any other collateralized loan might work.

 

[tulak]

A one time tax hit for a large distribution doesn't seem like a good idea to me, but perhaps if you are in the 32/35% tax bracket already it doesn't seem that bad.

Using IRS & State Tax Calculator | 2005 -- 2025 single and $100k tIRA withdrawal I get 13.61% in taxes. Are you including state income taxes in your higher numbers?

If your income from work puts you in the 32/35% tax bracket then I would agree that you should continue tax deferred savings as it is better to avoid paying 32/35% now and pay less later.

I think a 72t may be the best solution for you with withdrawals of Roth conversions supplementing 72t withdrawals if necessary.

If you own real estate you might do a cash out refinancing and put the proceeds in a taxable account. That would provide liquidity for the 55-59-1/2 period and then you can deal with paying it off after you are 59-1/2. Or for that matter any other collateralized loan might work.

I forgot about the standard deduction. Whoops.

And yes, I pay a lot in taxes. I guess I've built up immunity when seeing a big tax number!

So the overall tax is lower, but I'll still pay almost 5k more if I take out 200k vs 100k.

I will look into the 72t and see how that fits in.

As for borrowing money, I could get a HELOC, but I would need to run the numbers to know if that makes sense. I will think on this some more.

I've also been thinking of how ACA subsidies fit in. It might make sense for me to pay the extra 5k for withdrawing 2 years of living expenses at once if that means I qualify for an ACA subsidy for one of the years?

 

[pb4uski]

$5k more in tax on $100k more withdrawal, seems too good to be true. You might want to doublecheck that. Are state income taxes applicable?

 

[tulak]

$5k more in tax on $100k more withdrawal, seems too good to be true. You might want to doublecheck that. Are state income taxes applicable?

You're right. Math is hard.

It's ~5k/year, so 10k extra.

No state income taxes.

Luckily, I can afford to pay the extra tax if I have to, but no reason to pay it if I don't have to. Time to research 72t.

 

[pb4uski]

No, it has to be more than $5k a year. If one was single and only income was $100k of traditional IRA withdrawals your federal tax would be $13,614. For $200k of traditional IRA withdrawls the tax would be $37,247. The difference in tax is $23,633.

IRS & State Tax Calculator | 2005 -- 2025

Easily and accurately calculate IRS & State personal income taxes online.

www.irscalculators.com

 

[tulak]

No, it has to be more than $5k a year. If one was single and only income was $100k of traditional IRA withdrawals your federal tax would be $13,614. For $200k of traditional IRA withdrawls the tax would be $37,247. The difference in tax is $23,633.

IRS & State Tax Calculator | 2005 -- 2025

Easily and accurately calculate IRS & State personal income taxes online.

www.irscalculators.com

Are you thinking I'm taking 200k each year?

You take out $200k once, for two years of income. That's $37,247 in taxes.

You take out $100k twice, for two years of income. That's $13,614 in taxes, or $27,228 in total taxes for two years.

$37,247 - $27,228 = $10,019 taking the 200k withdrawal once versus 100k withdrawal twice.

Split over two years, that's $5,010 in taxes per year more for 200k vs 100k.

Unless I'm missing something?

 

[pb4uski]

Ah, I see what you are doing now. I thought it was one year and either $100k or $200k.