401K, IRA for early retirement and no taxes paid

[IGBT]

If you have a little bit of time for planning, there is yet another way to get money out of your 401K without penalty (and possibly without taxes).

It is a Roth pipeline. Essentially, any year where you are below the level to pay tax, fill out that 0% bracket with 401K to Roth conversions. The money in the Roth that you converted from your 401K can be withdrawn after 5 years with no tax, penalty, or even increasing your earned income.

The key is that capital gains and dividend income are taxed at 0% up to a pretty high level. Interest income, wages, and 401K to Roth conversions are taxed starting at a lower level.

As a married couple, you can earn $40,000 combined in earned income, conversions, capital gains, and dividends and still pay 0% tax. If you only need $20,000 to live on, you possibly could convert $20,000 of your 401K to Roth each year tax free. After 5 years you could start taking out this $20,000 from the Roth with no tax or penalty (or even increasing your MAGI for Obamacare subsidy qualification).

 

[planet-beaver]

Good one. Didn't think about that. Thanks

 

[flailer]

If you have a little bit of time for planning, there is yet another way to get money out of your 401K without penalty (and possibly without taxes).

It is a Roth pipeline. Essentially, any year where you are below the level to pay tax, fill out that 0% bracket with 401K to Roth conversions. The money in the Roth that you converted from your 401K can be withdrawn after 5 years with no tax, penalty, or even increasing your earned income.

The key is that capital gains and dividend income are taxed at 0% up to a pretty high level. Interest income, wages, and 401K to Roth conversions are taxed starting at a lower level.

As a married couple, you can earn $40,000 combined in earned income, conversions, capital gains, and dividends and still pay 0% tax. If you only need $20,000 to live on, you possibly could convert $20,000 of your 401K to Roth each year tax free. After 5 years you could start taking out this $20,000 from the Roth with no tax or penalty (or even increasing your MAGI for Obamacare subsidy qualification).

WOW WOW WOW !!!
I wish I would have known this long ago (not that I'm sad, or beating myself up)

One question: Would you want to open a new roth account every year? I am just wondering if the 5 year time frame applies to the final year within which the contribution was made? Or the first year?

 

[offroad]

And how is a normal non-math person supposed to follow all this for maximum benefit? Given obamacare premiums at $5000 a year, plus copay, plus 10% not covered, plus drug costs. Can a SS ONLY income at 62 cover all these costs? Yes I know Medicare can cover a lot, but you would still need supplemental obamacare

 

[HarmonicaBruce]

It is a Roth pipeline.

Ok, I'm 67, and the last few years I could have pipelined some money. I can withdraw, but I haven't because I like having the profits not be taxable. So if I converted some IRA into Roth, would I still have to wait 5 years to withdraw it without penalty? I sure wish I had known about this years ago!

 

[VanLifeCrisis]

lets say i have a non roth 401k with my employer. im only 36. i have no intention of keeping that money in there for some far distant retirement that may and probably wont ever materialize. definitely not staying at this job till then. so if i want to get that money out, do i have to quit my job to access it? im guessing that my employer match (80% match) to this point basically means hes paid the taxes on those wages for me.this crap is confusing.

 

[IGBT]

If you are working and have a 401K, don't cash it out. Don't touch it for loans, or to pay off credit cards, medical bills.

401K is one of the few assets totally protected from creditors if for some reason you declare bankruptcy or have a lawsuit against you. It is so sad to see people tap their 401K, pay the 10% penalty plus tax, use the money to try and plug a leak in their budget when the dam is going to fail no matter what they do.

If you switch employers you can convert part of the 401K to Roth each year if it will not hurt you too much on taxes.

The best way to do the pipeline is if you happen to have some cash on hand for living expenses (say from sale of home). If you live off the cash, you can convert some of the 401k each year and be below the income level to have to pay any tax at all. Five years later you can start withdrawing each of the previous contributions per year with no tax due. Tax deductible going in, tax free coming out. Win win.

 

[VanLifeCrisis]

i have no intention of keeping that money in there for some far distant retirement that may and probably wont ever materialize.

I am not sure i want to wait 22+ years (once again im 36) with 7k just sitting somewhere in the hopes ill live long enough to see it, or it wont get eaten alive by fees, inflation or whatever just to avoid some taxes.

That money could be an emergency fund now, or expenses between seasonal jobs etc. The more i read vandweller and rver blogs, at least the bluntly honest ones, the more i keep hearing that people wished they could have had 'done this' while they were younger and able to enjoy it.

Btw with the income thing, what if i pull this money out after i quit and i end up making below 10k? What would the tax hit look like then?m Or does that not come into play.

 

[IGBT]

Well, in 22 years invested at 4% real rate, the money will be $16,600 in today's dollars, not $7k.

If you pull it out now it will be gone in a couple of months and all you will have is regret in 22 years.

Best to just forget about it and let it grow.

 

[VanLifeCrisis]

Will i regret it though? I guess if i spent on cheeseburgers and crack i suppose so. What if it enabled lifestyle of travel and memories though? Would i still regret it?

Anyway, reading my retirement plans info, if i take it out im not clear if get the employer match. I have ameritas. They call it a 'employer safe harbor match' not an 'employer contribution' (they list this separately, and you definitely are entitled to any of employer contribution).

The wording is pretty unclear whether i would receive the safe harbor match. In one part it tells me im 100% vested in safe harbor contributions, and im entitled to funds im 100% vested in, but another small line says something about not being able to receive the safe harbor portion for hardships. But it also lists hardship as an 'in service withdrawl' which is different from a termination of employment withdrawl i think.

I wonder how honest they would be if i call em and say 'if i roll out in january, exactly how much before taxes will i be able to withdrawl"? Id have to do this on the phone with ameritas, the meeting with the 'agent' are watched over like a hawk by the owners and questions are frown upon.

 

[planet-beaver]

If you are 100% vested, the money is all yours when you quit the job. And you have to quit to be able to get that money out without doing loans or other hardship. at 7K you really dont have to worry about creditor protection. It's different when you have 500K. 401K offer creditor protections, IRAs don't. The key is to leave the bulk of the money in your employer 401K and transfer small amount to IRA for cash redraws. Unless you find IRA that has much lower fees and better %, then the risk may be worth it.

Vanguard for example has the lowest fees in the industry charging 0.1 - 0.25 while others charge up to 2.0%.
On 500k, that's $10,000

---

Also, the money you save or make in better IRA vs 401K can be used to buy personal umbrella liability policy which runs about $500 per year for $5 million coverage. SO if you are paying $10,000 in fees and switch to Vanguard IRA or Personal 401K and pay only $1000 in fees. It is worth paying $500 for a policy. These insurance companies have best lawyers to defend you in case you have a judgment against you (some one is suing you for something). And believe me, this happens all the time. There are people out there just looking for retired people with nice RVs. All they have to do is slam on their brakes and get rear ended. Rvs dont stop like cars.

 

[offroad]

So another factor in financial pitfall potholes. Scumbag lawsuits ready to take you to court. If you can find a lawyer. -- kind of feel this is a rather large myth.

Unless lawyer teamed up with scumbag medical doctor to exaggerate the medical issues.

That could be a horror fiscal story.

 

[IGBT]

Actually the Supreme court just ruled that IRAs get the same protection as pensions and 401Ks in bankruptcy, so there is little reason to keep your 401K money in a 401K after you leave your job if the fees are high.

This does not mean take the money out and pay penalty, but you can roll the entire 401K over to a regular IRA with no penalty or taxes. You can then invest in ETFs like VTI (the total stock market) which has an annual fee of 0.05% and pays about 1.6% in dividends.

For a $500,000 IRA, that would be $250 a year in fees and $8000 in dividends.

If you don't have a lot of other income, you can convert a small portion of the rolled over IRA into a Roth IRA each year with no taxes or penalties. The Roth is also protected from bankruptcy/creditors.

Note that divorce is the weapon of mass destruction that can blow through all of this protection. It is like a uranium tipped armor piercing shell.

 

[offroad]

Saying someone here has $500,000 is crazy talk. Lol. cheap RV living most likely means Social security level $12,000 a year which at 5% annual return translates to a 401k account of $240,000. Find it funny that most social security folks do not realize they have $240,000 equivalent in the bank.

 

[IGBT]

Well, yes maybe speculating that most people on here have $500,000 in a retirement account borders on crazy but it could be possible to accumulate that without ever having a rich income.

Take that gate guard thing for example. Free parking, free water, generator fuel. $150 a day. You could easily put away $10,000 a year or more into a solo 401K with no taxes (the gate guard is contract work so you could do a solo 401k). You could get the savers credit which is a 50% match on the first $2000 (so $1000) from Uncle Sam.

$11000 a year for 5 years would be around $65,000 at 7% return. If you did that in your late 20s for just five years then at age 60 it would be about $494,000.

 

[offroad]

Very few in their 20 think that way. Target audience should be desperate folks in their 40s and 50s with no savings. That's who need the help. --- just me ranting about how advice for 20 year olds is wasted.

 

[flailer]

... divorce is the weapon of mass destruction that can blow through all of this protection. It is like a uranium tipped armor piercing shell.

NOW you tell me !!!

 

[flailer]

New for 2015:

Additional Tax credit, for low income, contributors:

"Saver's credit. Workers who save in a 401(k) or IRA may be eligible for the saver's credit if their AGI is less than $30,500 for singles, $45,750 for heads of household and $61,000 for married couples in 2015. These limits are between $500 and $1,000 higher than in 2014. This valuable tax credit is worth 50 percent, 20 percent or 10 percent of your 401(k) or IRA contributions up to $2,000 ($4,000 for couples), with the biggest credit going to savers with the lowest incomes. The maximum possible saver's credit is worth $1,000 for individuals and $2,000 for couples."

LINKY-LINK

p.s. wish it had info on changes to Roth 401K !!
p.p.s. do your own research. don't hold me accountable.
p.p.p.s. HUGE THANKS to IGBT & Planet-Beaver

 

[VanLifeCrisis]

so does that apply when i do taxes coming up or in 2016?

 

[flailer]

I believe you will find, when you look for yourself, that it applies to the tax year 2015. Plan and act accordingly, so that when you file early 2016 you have already taken maximum advantage.

(kindly confirm all of this for yourself, because, as you can see the info is from a third party, not from the Gov) (that said, you should already be able to confirm the numbers for 2014, as the IRS has released the forms and supporting instructions, yes?)