How to get some taxable income out of a 401k quickly

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tashina
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How to get some taxable income out of a 401k quickly

Post by tashina »

Hi all,

I've been admin-ing here since the forum was created (mostly behind the scenes), but not sure I've ever asked an investing question. Guess it's about time! :) Wish I'd worked on this problem sooner but family medical emergencies delayed me, so now I need some quick advice.

Since I'm not posting anonymously, I don't want to list exact numbers but I don't think they are needed, but here is general info:
Ages: me 53, husband 57
Income this year before disbursement: retired early - $13k (We mostly have post-tax money so not a lot of income to show, just interest and capital gains)
401k: $100k, owned by husband, left job with that 401k at 55.

I am wanting to pull $10,000 of the $100,000 in the 401k into taxable income to hit the right income for the health care subsidy for 2017 if possible. I maximized my subsidy by estimating the lowest income without qualifying for Medicaid, assuming that we could withdraw from the 401k whatever was needed. My original easy plan was just to remove $10,000 penalty-free this year because of the age 55 rule for 401ks. I didn't realize until I went to do it last night that Fidelity doesn't allow partial 401k distributions - all or nothing.

Had a few ideas:
1) rollover to a IRA, then withdraw the $10k but he isn't 59.5 so we run into a 10% penalty.
2) Take the money in cash and rollover all but $10k to an IRA within 60 days - any downsides?
3) rollover to a mixture of traditional IRA ($90k) and Roth IRA ($10k). I don't even know if this is possible. But seems like that would make $10k in taxable income.
4) do nothing and just report $10k less income than expected. I should have been on Medicaid all year in that case, but my understanding is there is no penalty for underestimating income below the poverty level. But I will still run into this issue again next year when I may need some additional income for the subsidy.

Would love to hear any suggestions. Thanks in advance. Next year, I'll need to ask for investment advice for the money we have in the 401k/IRA. We picked some investment options about 6 years ago and just never changed/reviewed the choices.
Ace1
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Re: How to get some taxable income out of a 401k quickly

Post by Ace1 »

Tashina,
If you are trying to create income on your tax return, but dont need the cash,
I think doing the rollover to an ira, and then converting the 10k to a roth accomplishes that.
If you can do that in one step instead of two, even better.
I would suggest if you do this, to do it at fidelity since time is of the essence.

I find it curious fidelity wont let you do a partial distribution.... it must be something in the
specific rules for that 401k... although that might be because you are under 59.5.
The 401k the company I worked for is at fidelity, and that plan allowed partial distributions, both
in service and after.
rkhusky
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Re: How to get some taxable income out of a 401k quickly

Post by rkhusky »

If you can't withdraw from IRA without incurring 10% penalty, how could you withdraw from 401k without incurring the penalty (re #2)? As Ace1 says, rolling over to Roth seems like the best bet.
panhead
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Re: How to get some taxable income out of a 401k quickly

Post by panhead »

Ace1 wrote: Wed Dec 13, 2017 10:40 am Tashina,
If you are trying to create income on your tax return, but dont need the cash,
I think doing the rollover to an ira, and then converting the 10k to a roth accomplishes that.
If you can do that in one step instead of two, even better.
I would suggest if you do this, to do it at fidelity since time is of the essence.

I find it curious fidelity wont let you do a partial distribution.... it must be something in the
specific rules for that 401k... although that might be because you are under 59.5.
The 401k the company I worked for is at fidelity, and that plan allowed partial distributions, both
in service and after.
I think this makes a lot of sense. You are essentially doing a partial Roth conversion which will show as income and be taxable, which in your case you should be doing anyway with the low income you show. I agree with doing it at fidelity as well, and I'm fairly certain they can do it in one step. One caution: I would prepare an early 2017 tax return (maybe thru taxcaster or freetaxusa or even on paper) so you can see what the full effect on your situation is, and ensure that you convert the right amount to show the level of income you desire, to get the ACA subsidy level you are shooting for.
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Re: How to get some taxable income out of a 401k quickly

Post by KlangFool »

rkhusky wrote: Wed Dec 13, 2017 10:46 am If you can't withdraw from IRA without incurring 10% penalty, how could you withdraw from 401k without incurring the penalty (re #2)? As Ace1 says, rolling over to Roth seems like the best bet.
rkhusky,

OP could because there is a special exemption for 401K when a person retired at 55 years old that does not exist for IRA.

http://www.401khelpcenter.com/401k_educ ... jFbpd-nH-g
<< Leaving Your Job On or After Age 55

The age 59½ distribution rule says any 401k participant may begin to withdraw money from his or her plan after reaching the age of 59½ without having to pay a 10 percent early withdrawal penalty.

There is an exception to that rule, however, which allows an employee who retires, quits or is fired at age 55 to withdraw without penalty from their 401k (the "rule of 55"). There are three key points early retirees need to know.>>

KlangFool
Last edited by KlangFool on Wed Dec 13, 2017 10:57 am, edited 1 time in total.
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Ace1
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Re: How to get some taxable income out of a 401k quickly

Post by Ace1 »

Rkhusky,
There is a rule (72t I believe), that allows equal distributions at/after age 55 for 5 years or attaining age 59.5
and that avoids the 10% penalty.
KlangFool
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Re: How to get some taxable income out of a 401k quickly

Post by KlangFool »

Ace1 wrote: Wed Dec 13, 2017 10:56 am Rkhusky,
There is a rule (72t I believe), that allows equal distributions at/after age 55 for 5 years or attaining age 59.5
and that avoids the 10% penalty.
Ace1,

It is not 72t. You do not need equal distribution.

http://www.401khelpcenter.com/401k_educ ... jFbpd-nH-g

<< Leaving Your Job On or After Age 55

The age 59½ distribution rule says any 401k participant may begin to withdraw money from his or her plan after reaching the age of 59½ without having to pay a 10 percent early withdrawal penalty.

There is an exception to that rule, however, which allows an employee who retires, quits or is fired at age 55 to withdraw without penalty from their 401k (the "rule of 55"). There are three key points early retirees need to know.

First, this exception applies if you leave your job at any time during the calendar year in which you turn 55, or later, according to IRS Publication 575.

Second, if you still have money in the plan of a former employer and assuming you weren't at least age 55 when you left that employer, you'll have to wait until age 59½ to start taking withdrawals without penalty. Better yet, get any old 401k's rolled into your current 401k before you retire from your current job so that you will have access to these funds penalty free.

Third, this exception only applies to funds withdrawn from a 401k. IRAs operate until different rules, so if you retire and roll money into an IRA from your 401k before age 59½, you will lose this exception on those dollars.>>

KlangFool
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Ace1
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Re: How to get some taxable income out of a 401k quickly

Post by Ace1 »

KF,
Thanks for the clarification.... 72t appears to be usable regardless of age, whereas the pub 575 rule
is for those 55 and above and allows unequal amounts...
In any case, there are penalty escape routes.
Ace
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tashina
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Re: How to get some taxable income out of a 401k quickly

Post by tashina »

Thank you for the opinions so far! So it's possible to rollover into a combo of traditional IRA and Roth IRA? Would I be able to make (small) transfers from the traditional to the Roth in future without penalty (assuming low income)? I can do some 72(t) distributions if not.

Also, I haven't done a rollover since the 90's (for my day who had dementia). We have investments now that I'm sure aren't ideal and with the IRA I assume I will incur trading fees of some sort. Below is our current mix, which was picked years ago. Should I convert to cash initially or do I tell them what new investments I want? I'd be happy to have suggestions on a few funds. We have a high but not extreme risk tolerance because right now our money is mostly in real estate and cash (that needs fixing too).

AF GRTH FUND AMER R6 36.72%
FID DIVERSIFIED INTL K 24.56%
GS SM CAP VALUE INST 21.30%
VANG INST TR 2040%
MIP II CL 1 1.30%
VANG INST TR 2025% .88%
KlangFool
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Re: How to get some taxable income out of a 401k quickly

Post by KlangFool »

tashina wrote: Wed Dec 13, 2017 11:27 am Thank you for the opinions so far! So it's possible to rollover into a combo of traditional IRA and Roth IRA? Would I be able to make (small) transfers from the traditional to the Roth in future without penalty (assuming low income)? I can do some 72(t) distributions if not.

Also, I haven't done a rollover since the 90's (for my day who had dementia). We have investments now that I'm sure aren't ideal and with the IRA I assume I will incur trading fees of some sort. Below is our current mix, which was picked years ago. Should I convert to cash initially or do I tell them what new investments I want? I'd be happy to have suggestions on a few funds. We have a high but not extreme risk tolerance because right now our money is mostly in real estate and cash (that needs fixing too).

AF GRTH FUND AMER R6 36.72%
FID DIVERSIFIED INTL K 24.56%
GS SM CAP VALUE INST 21.30%
VANG INST TR 2040%
MIP II CL 1 1.30%
VANG INST TR 2025% .88%
tashina,

Do you have any pre-tax IRA now? Aka, Rollover IRA or just Trad. IRA?

<<Would I be able to make (small) transfers from the traditional to the Roth in future without penalty (assuming low income)?>>

It is not a transfer. It is a Roth conversion. You could do that without touching the 401K.

https://www.bogleheads.org/wiki/Roth_IRA_conversion

KlangFool
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Re: How to get some taxable income out of a 401k quickly

Post by Ace1 »

Tashina,
Yes you can continue to make tIRA to Roth conversions in future years.
Making those conversions at little or zero tax cost are optimal.
Depending on your overall position, you might convert the entire 401k/tIRA over
the next several years and be totally Roth before your DH turns 70.5 and
eliminate RMDs.
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tashina
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Re: How to get some taxable income out of a 401k quickly

Post by tashina »

KlangFool wrote: Wed Dec 13, 2017 11:42 am tashina,

Do you have any pre-tax IRA now? Aka, Rollover IRA or just Trad. IRA?
No, just the 401k. We've never had an IRA. I believe our combined income was too high to allow for the tax advantage, so we just contributed a lot to the 401k.

Ace1, thanks, we'll keep that in mind. For the subsidies it's good to keep it low right now, but who knows what will happen to health care over the next couple years.
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Re: How to get some taxable income out of a 401k quickly

Post by rkhusky »

KlangFool wrote: Wed Dec 13, 2017 10:54 am
rkhusky wrote: Wed Dec 13, 2017 10:46 am If you can't withdraw from IRA without incurring 10% penalty, how could you withdraw from 401k without incurring the penalty (re #2)? As Ace1 says, rolling over to Roth seems like the best bet.
rkhusky,

OP could because there is a special exemption for 401K when a person retired at 55 years old that does not exist for IRA.

KlangFool
Thanks. I think I've seen that mentioned, but didn't pay attention since it didn't apply to me.
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Re: How to get some taxable income out of a 401k quickly

Post by curmudgeon »

Roth conversions are a good way to generate taxable income (on paper) to keep you above the ACA bottom limit. You DO need to do a bit of research to be aware of various limitations. If the 401K doesn't allow partial withdrawals, it may not allow partial conversions to a Roth either. In that case doing a rollover to IRA, followed by partial Roth conversion would be the path. Making sure it can get done in time will be important. There are some limitations about taking the converted money out of the Roth IRA within 5 years of creating the Roth, so make sure you understand those details.

If you have taxable market investments where you could "capital gain harvest", that might be another option.
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Re: How to get some taxable income out of a 401k quickly

Post by Ace1 »

Tashina,
One more thing to consider.... if you go ahead and do the rollover at fidelity, BEFORE you execute that, inquire
what fees you would see for selling in the 401k versus selling in the ira at fidelity.
If selling in the 401k is less expensive, consider moving some to cash / money market before the rollover.
I think getting fidelity funds in the fidelity ira would most likely be low/no cost.
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Re: How to get some taxable income out of a 401k quickly

Post by tashina »

curmudgeon wrote: Wed Dec 13, 2017 12:04 pm
If you have taxable market investments where you could "capital gain harvest", that might be another option.
That's a great idea. We do have a bunch of stock we've held for ages, and I bet that would help and might let us put off the IRA decisions until next year. Thanks for the suggestion.
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Re: How to get some taxable income out of a 401k quickly

Post by Epsilon Delta »

KlangFool wrote: Wed Dec 13, 2017 10:59 am
It is not 72t. You do not need equal distribution.
I haven't got time to search the US Code right now but I believe both the SEPP (Substantially Equal Periodic Payments) and the 401(k) separation after age 55 exceptions are in the same subsection, 72(t), right after it define the 10% early withdrawal penalty.
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Re: How to get some taxable income out of a 401k quickly

Post by curmudgeon »

tashina wrote: Wed Dec 13, 2017 3:40 pm
curmudgeon wrote: Wed Dec 13, 2017 12:04 pm
If you have taxable market investments where you could "capital gain harvest", that might be another option.
That's a great idea. We do have a bunch of stock we've held for ages, and I bet that would help and might let us put off the IRA decisions until next year. Thanks for the suggestion.
If you can do that, it would definitely be easiest (and probably not cost you anything in tax, with LTCG rate at your income). And for gains, you don't have to worry about "wash sale" rules, the way you would need to do for loss harvesting. If you want, you can buy back the stock the same day. DO pay attention to details of the specific lots and their cost basis if there were multiple purchases of the stock in the past.

If you expect to be in a higher tax bracket in the future (RE investments run out of depreciation space, SS, pension, etc), you might look at whether you should run your income somewhat higher for the next few years via gains harvesting or Roth conversions, though there are tradeoffs vs ACA subsidies.
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Re: How to get some taxable income out of a 401k quickly

Post by Epsilon Delta »

Here is a table of exceptions to the 10% penalty:
https://www.irs.gov/retirement-plans/pl ... tributions
Tashina should probably skim the table to see if any of them fit her circumstances. It's possible she qualifies for the first time home owner exemption or one of the other odd ones. Stranger things have happened.

As I mentioned above many of the exceptions are in 72(t)
  • being over age 59.5 is 72(t)(2)(A)(i)
  • SEPP is 72(t)(2)(A)(iv)
  • Separation from service is 72(t)(2)(A)(v), unless you're in public safety then its 72(t)(10)
Calling SEPP 72(t) and the others not 72(t) is terminologically inexact.
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Re: How to get some taxable income out of a 401k quickly

Post by tashina »

curmudgeon wrote: Wed Dec 13, 2017 4:15 pm If you can do that, it would definitely be easiest (and probably not cost you anything in tax, with LTCG rate at your income). And for gains, you don't have to worry about "wash sale" rules, the way you would need to do for loss harvesting. If you want, you can buy back the stock the same day. DO pay attention to details of the specific lots and their cost basis if there were multiple purchases of the stock in the past.

If you expect to be in a higher tax bracket in the future (RE investments run out of depreciation space, SS, pension, etc), you might look at whether you should run your income somewhat higher for the next few years via gains harvesting or Roth conversions, though there are tradeoffs vs ACA subsidies.
I just wanted to say a final thank you to everyone, especially curmudgeon. We sold the exact number of shares of stock needed to generate the desired income. E-trade (that's where his company kept the stock grants and we hadn't moved it) had all the basis/gain info and made it really simple. I downloaded Turbotax 2017 to mock up all the income sources for the year before we made the sale. It will all turn out really well, because we were a bit over-invested in his company stock, which we were more comfortable with when he worked there, but shouldn't be keeping so much in one single stock now. We'll transfer that money over to our CD ladder. This strategy should work for us until my husband is 59 1/2, if the ACA rules don't change before then. And yes, we do intend to balance wanting to maximize the subsidy (within the rules) with also wanting to convert IRA/capital gains money to income during years where our income is low.
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