Tax avoidance strategies for withdrawal from large 401k?

[RetireBy90]

Interesting post by Phrugal. I read OP as looking at conversions not if he should contribute to the Roth version. Then when he posted that the 457 has a Roth I didn't think of current contributions.

My experience with 401K was final 4 years of work at top of my income, I contributed 25% to the Roth 401K. Company match and a kicker bonus at end of each year went into the traditional 401K.

My company plan didn't allow for partial distribution to an IRA so I waited till I retired and had the entire balance of both traditional and Roth transferred to my IRAs, then started doing conversions from tIRA to the Roth.

If I had done more years of Roth rather than traditional 401K I wouldn't be in the position I find myself today with extreme bump of my income in order to get funds converted. Or, if I had it to do over again I would have been contributing to the Roth 401K all along. I would have paid tax on contributions at the time and what ever I had in the account would be mine. Today I find that I'll be in 24% federal and 5.75% state so only 2/3 of the funds are really mine. Not to mention the hit on Medicare IRMAA and extra tax on SS and so on and so on. I figure about 60% of the funds in tIRA are mine, the rest will be claimed by others.

 

[bada bing]

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.

People without access to a "qualified" employer sponsored plan are very much at a disadvantage compared to those that do, given enough money to direct towards tax advantaged savings. Additionally, all employer plans are not even close to equal in the advantages they have.

You asked a bunch of questions about conversions from a 457 plan. The rules and potential benefits can get a more than a little convoluted, but are well worth some study. It is possible your 457 plan may allow a maneuver called the "mega-backdoor Roth". That is where you can deposit additional after tax money into your 457 in excess of the qualified limits and then immediately roll those funds into a Roth IRA. Not all plans allow the actions required. The plan has to allow non-Roth after tax contributions and in-service rollovers. If your plan allows this, you could potentially shuttle an additional ~$30K per year into a Roth IRA on top of other contributions and conversions. Because money is "fungible", the maneuver can be used to shuttle money held in taxable savings into a Roth even if you don't have enough current income to comfortably contribute the full amount from ongoing payroll.

Definitely worth a little investigation. I have moved ~$200K in regular savings into a Roth IRA on top of full annual contributions using this over the last 7 years.

 

[TonyClifton]

People without access to a "qualified" employer sponsored plan are very much at a disadvantage compared to those that do, given enough money to direct towards tax advantaged savings. Additionally, all employer plans are not even close to equal in the advantages they have.

You asked a bunch of questions about conversions from a 457 plan. The rules and potential benefits can get a more than a little convoluted, but are well worth some study. It is possible your 457 plan may allow a maneuver called the "mega-backdoor Roth". That is where you can deposit additional after tax money into your 457 in excess of the qualified limits and then immediately roll those funds into a Roth IRA. Not all plans allow the actions required. The plan has to allow non-Roth after tax contributions and in-service rollovers. If your plan allows this, you could potentially shuttle an additional ~$30K per year into a Roth IRA on top of other contributions and conversions. Because money is "fungible", the maneuver can be used to shuttle money held in taxable savings into a Roth even if you don't have enough current income to comfortably contribute the full amount from ongoing payroll.

Definitely worth a little investigation. I have moved ~$200K in regular savings into a Roth IRA on top of full annual contributions using this over the last 7 years.

Though I just discovered my work 457 plan allows me to make either or both untaxed contributions to the 457 and taxed contributions to the 457 Roth, I first need to deal with the two 401k accounts from previous employers (me and DW.) Since there is ~$550k in there now, converting them to the Roth IRA would seem to require several years of conversions before I can turn my attention to the 457. A bit of urgency is felt because the tax rates a few years from now will be quite likely higher.

Here's a question: If one is making withdrawals from a 457 post-retirement and doesn't have an ongoing need for some or all of the money, wouldn't it make sense, if federal tax needs to be paid either way, to have the withdrawal sent to a Roth IRA instead of a direct payment? For the direct payment, any investment return from that point on such as dividends and CG needs to be dealt with each year tax-wise. For the Roth, all these returns are tax free, forever. Why would anyone NOT funnel the withdrawals through the Roth?

 

[RetireBy90]

I would say you have the answer correct according to my thinking. No reason to take a withdraw and move to taxable account rather than move to Roth.

 

[deserat]

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.

Wow - that is one nice Roth perk! Wish TSP would get off their a$$ and allow Roth conversions (they have the lowest fees) .....although I can and do contribute the max (catch up for me as I'm over 50) to the Roth as well as the max to the tax deferred. As it is, I will have to rollover into an IRA and then convert when I pull the plug. My tax deferred is in high 6 figures and I'm single, so the tax bite BITES....with all of my late night i-ORP, FireCalc and personal model calculations, it will be best for me to convert before SS. I will also always blow past any of those IRRMA and other gates. I will be taking the hit (once again) for many....a life of service, I tell ya, a life of service I've had....
;-)

 

[TonyClifton]

As I've mentioned, my 401a and 457 plan are administered by ICMA-RC which I'm guessing is a big outfit with lots of government clients. I sent ICMA an email with two specific questions: upon retirement (1) will I be able to convert 401a funds into a Schwab Roth IRA and (2) will I be able to convert 457 funds into a Schwab Roth IRA. Here is their reply in total:

"Yes, upon retirement, you will be able to transfer your funds to another provider."

I am unsure if this is a good answer. I do note that these companies are not in the business of making it easy to withdraw funds. For example, there is no problem getting all the information and forms you need to transfer money INTO the account (they are enthusiastic about you "consolidating" your retirement accounts) but information about taking money out is literally in fine print here and there.

I guess I will call them and ask a person my questions again.

 

[braumeister]

I do note that these companies are not in the business of making it easy to withdraw funds.

Unlikely to be a problem for you. Just open the Roth at Schwab, give them the phone number of your current provider, and let them jump through the hoops. They do this every day and since the money will be coming to them, they will be motivated to get it done quickly.

 

[RetireBy90]

Unlikely to be a problem for you. Just open the Roth at Schwab, give them the phone number of your current provider, and let them jump through the hoops. They do this every day and since the money will be coming to them, they will be motivated to get it done quickly.

Fidelity did same for me. I just told them account number and they got funds transferred.

 

[eddiegorniakjr]

It sounds like you either aren't yet 72 (age at which RMDs are required), or you are taking out over and above your RMD. Rather than withdrawing the funds, why don't you convert them to a Roth IRA, where they will grow untaxed? You may have to do the intermediate step of rolling the 401K to an IRA first, but that shouldn't be a big deal. The conversion is taxed just like your withdrawal, but you don't have to worry about investing with low taxes in mind inside the Roth.

If I die and have money in my Roth IRA will my beneficiaries have to pay taxes when they close my Roth IRA? Or does it somehow pass to my beneficiaries without them having to pay taxes on it? Would I be better off if I close it now?

 

[SecondCor521]

If I die and have money in my Roth IRA will my beneficiaries have to pay taxes when they close my Roth IRA? Or does it somehow pass to my beneficiaries without them having to pay taxes on it? Would I be better off if I close it now?

Typically your beneficiaries would get their portions transferred to an inherited Roth IRA. They would have to drain the account within 10 years but would pay no taxes on their withdrawals.

 

[samcat]

I can't see where this has been addressed but maybe it has already been said.

In the recent tax law, non spousal beneficiaries have to take distributions from the total account within ten years of the death of the original account holder.

So, if you have $2M in pretax accounts and have two beneficiaries, they would have to take $100k out each per year for ten years. This will definitely impact their tax brackets.

Having too much in pretax is definitely a problem.

I remember calling my dad after I read this and asked him how much he has in pre-tax...luckily he only has about $100k left since he has been doing Roth conversions all along.

https://www.marketwatch.com/story/t...-are-you-affected-by-the-new-rules-2019-12-27

 

[Jim in PA]

Too much of a good thing

I know what you mean.

When I pass, I am sure my heirs will react poorly upon learning that I have left them tens or hundreds of thousands of dollars that are UNTAXED, including the money to pay those taxes.

" This was no man, this was a monster!", they will surely exclaim!

I’m working at converting ALL of my traditional IRA to Roth. With the Secure Act provision that the account must be emptied in 10 years (for a non-spouse), a taxable account may well be a burden. Suppose that your heir inherits $1M and at the time, she/he is in a peak earning zone, with $300K in salaries. The 10 year rule has them adding $100K to their taxable income, taxed at their marginal rate. Ouch! I WELL understand that I’m paying (or prepaying) those same taxes, but it’s just a cleaner package to leave the money as Roth with all taxes paid.

They may not call you a monster, but they may lament the lack of tax planning for them.

 

[dixter]

I didn't see this mentioned and it could be important for a few.... the IRS counts Roth Conversions as income and the IRS reports that income to the Medicare Folks...

The Medicare folks can go back 2 years for income ... so if you are going on medicare when you reach 65, like most, then they will look back two years and determine how much they are going to charge you for your monthly medicare premiums... don't forget, medicare is a single payer plan... so you could end up with you and your spouse getting a huge monthly premium each month... don't be surprised...

 

[TonyClifton]

I didn't see this mentioned and it could be important for a few.... the IRS counts Roth Conversions as income and the IRS reports that income to the Medicare Folks...

The Medicare folks can go back 2 years for income ... so if you are going on medicare when you reach 65, like most, then they will look back two years and determine how much they are going to charge you for your monthly medicare premiums... don't forget, medicare is a single payer plan... so you could end up with you and your spouse getting a huge monthly premium each month... don't be surprised...

That is a good point.

Though I can't say I should have saved less than I did, I did not set out intending to have to deal with upper end tax complications, I assumed a drawdown of retirement funds like a regular old annuity.

Obviously something has to give here. It's not possible to make large transfers over a number of years to a Roth IRA and still enjoy the Medicare premiums available to those with less income to declare. Although I fully expect to chafe at higher Medicare costs, I am guessing it will pencil out that I need to be more concerned about not paying 37% or 39% in federal tax when 22% or 24% is available now.

I'm trying to not step over dollars to save pennies but all one can do is create spreadsheets with scenarios that seem reasonable, allowing for best and worst cases, and make decisions.

Something that I haven't seen mentioned much is the powerful compound interest function of a Roth. Investment returns from the time of conversion not being taxed is very powerful over a number of years as compared to "normal" distributions from a retirement plan. Even at a 24% federal tax rate at conversion, the compounding can recover quite a lot of the "loss" if invested for 10-30 years.

 

[dixter]

I do my taxes like this... My income is fixed... I know exactly how much money I want/need each year... so on Jan1 I withdraw the money I need for the next years expenses... Property Tax's, Home Insurance, Health Insurance, Car Insurance...and all of the other bills that will need to be paid... water, electric...ect..ect.. and I budget for travel and lesure... from this distribution I know exactly how much taxes I will owe for this withdraw and so next year on Jan 1 I also take a distribution for the Taxes owed for the previous year draw down... I never touch the Roth funds as it just seems a waist to take those funds until later down the road if tax rates go up... I also don't touch the HSA accounts as you might need that money when you get older and possibly sick .... so those accounts just sit and grow.. you need to take into account as to when you plan on passing away... in most cases, not all, you might retire at 65 and there seems to be a whole lot of folks not making it past 85... thats only 20 yrs...so my fixed income for those years are in bonds... and I chose the bonds with a maturity date so when they mature I get the $1000/bond value back and that becomes my yearly draw... I will have plenty to last till at least 95yrs... but I don't think the 95yr will be obtained... so money wise... some will be left behind... either for the kids or the wife if she lasts longer than I do... so as to taxes again... they are paid via the draw down each yr... you just have to budget for it each year and pay it when it comes due...who knows, when those bonds mature and I start to draw those funds down then I'll use the roth funds to pay the taxes on those...seems to be working so far...

 

[Splash]

In the recent tax law, non spousal beneficiaries have to take distributions from the total account within ten years of the death of the original account holder.

So, if you have $2M in pretax accounts and have two beneficiaries, they would have to take $100k out each per year for ten years. This will definitely impact their tax brackets.[/url]

The SECURE Act requires beneficiaries to withdraw all inherited funds within 10 years but they can do it however they want. They can take all funds out on day 1, they can wait and withdraw all funds on the last day (10 years minus 1 day), or they can withdraw various amounts throughout the 10 years. The only thing that is required is that all funds are withdrawn within the 10 year period.

 

[TonyClifton]

I do my taxes like this... My income is fixed... I know exactly how much money I want/need each year... so on Jan1 I withdraw the money I need for the next years expenses... Property Tax's, Home Insurance, Health Insurance, Car Insurance...and all of the other bills that will need to be paid... water, electric...ect..ect.. and I budget for travel and lesure... from this distribution I know exactly how much taxes I will owe for this withdraw and so next year on Jan 1 I also take a distribution for the Taxes owed for the previous year draw down... I never touch the Roth funds as it just seems a waist to take those funds until later down the road if tax rates go up... I also don't touch the HSA accounts as you might need that money when you get older and possibly sick .... so those accounts just sit and grow.. you need to take into account as to when you plan on passing away... in most cases, not all, you might retire at 65 and there seems to be a whole lot of folks not making it past 85... thats only 20 yrs...so my fixed income for those years are in bonds... and I chose the bonds with a maturity date so when they mature I get the $1000/bond value back and that becomes my yearly draw... I will have plenty to last till at least 95yrs... but I don't think the 95yr will be obtained... so money wise... some will be left behind... either for the kids or the wife if she lasts longer than I do... so as to taxes again... they are paid via the draw down each yr... you just have to budget for it each year and pay it when it comes due...who knows, when those bonds mature and I start to draw those funds down then I'll use the roth funds to pay the taxes on those...seems to be working so far...

Sounds like you've applied the proper energy to the topic...good plan. If you shoot for 95, well, if you go longer, it's time to contact the kids and say, "Remember that down payment on your house me and your mom made?"

In all seriousness, a 95 year old guy can get away with anything.

 

[wildbilly]

401K's are 100% federally protected VS IRA's are protected by the state up to some amount like $150K. You cannot buy this type of insurance so for that reason I will always keep as much of my money as possible in a 401K until the RMD kicks in.

Otherwise a in-plan roth conversion is a great option if it's available and doesn't have ridiculous fees.

Good luck!

 

[pb4uski]

401K's are 100% federally protected VS IRA's are protected by the state up to some amount like $150K. You cannot buy this type of insurance so for that reason I will always keep as much of my money as possible in a 401K until the RMD kicks in.

Otherwise a in-plan roth conversion is a great option if it's available and doesn't have ridiculous fees.

Good luck!

Nah.... anyone can easily buy that type of insurance.

Never sued anyone and never been sued. Only car claims have been minor fender benders. Plus $2m umbrella.

IMO the benefit of having greater control over my money and access to a wider variety of investment options far exceed the remote risk of loss from a lawsuit, especially with a multi-million umbrella in place.

 

[VungTau]

Real estate investments can offer a lot of tax saving opportunities via depreciation, book losses and such. You can generate good cash flow without minimal tax impact if you pick the right investment. I invested in a RE venture that has delivered exactly that. I never wanted to be a landlord, too much work and too many horror stories - this has given the benefits without the headache.

 

[pb4uski]

But they nail you with taxes via depreciation recapture and capital gains when you sell.

Besides, I think the topic is tax deferred accounts so why stretch to put a tax efficient investment in a tax deferred account.

When all you have is a hammer every problem looks like a nail.

 

[schellem]

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.

Just to further clarify, the heirs cost basis steps up to 100K on day of death.