Author Topic: Early Retirement Investing - Tax Strategies  (Read 21222 times)

mrmoneygoatee

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Early Retirement Investing - Tax Strategies
« on: February 24, 2012, 10:22:39 AM »
I am in search of tax strategy advice related to early retirement. Any help is greatly appreciated!

I admit that I am a novice in this area, so even if someone could point me to a solid book or site to get started, that would also be lovely.


Below are more details to put it in context.

I am 28 and would like to become "financially independent" by 43 (in 15 years)--my goal is to earn $30k/year in passive income from investments by the time I am 43.

I currently put 7% of my income in pre-tax 401k through my company. This gives me their full match (3.5%). I project to have $400k in this account by 43 and $1.5MM by 65 if I cease contributions at 43 and earn 6% interest after that. This is enough to fund post-65 retirement, and I also should get a very healthy pension, so I don't wish to contribute more to accounts that I can't access until 65.

My mortgage will be paid off in 15 years (or less), and I will have no other debt. (My only other debt now is a student loan.)

I plan to save >$25k/year above and beyond mortgage (3.5%), 401k, Health Savings Account, Daycare Flex Spending, 529 College Savings, and Student Loan (3.875%) payments. This amount will increase directly with my income, which I expect to increase at least 3%/year.

I project that I will make $30k/year interest on this extra investment after 14 years if I earn 6% return.

These are my basic plans. I realize that 6% may be a little optimistic, but that is how I did it for now. I can adjust things accordingly if I change that.

Right now, I have $20k in an online savings account with Ally. I would like to use some of this to get started in addition to the $25k/year I will begin contributing ASAP.

My work's pre-tax 401k is through Fidelity. I can also contribute to a Roth or an after-tax option.

I have read good things about the Vanguard accounts, and I feel Vanguard or Fidelity Index funds would fit my style. However, I am concerned about putting my money in these accounts without fully understanding the tax implications.

I understand that dividends are taxed as income even if they are reinvested, and reinvesting them causes changes in your cost basis used to calculate capital gains on distribution, which can get complicated to track. I'd like to avoid this complication if possible.

Honestly, I'd just like to invest my money is several diversified index funds across stocks and bonds, and not pay gains taxes until after I begin using the money after 43. Is this possible? Or will I always be paying gains taxes as the interest is reinvested no matter what path I take?

Should I be contributing to a Roth, knowing I want benefits from this investment at age 43? I've heard there are loopholes for accessing this money without penalty. Is this true?

I saw there are "tax managed" Vanguard accounts. How do those work?


Again, my apologies for my lack of expertise here, just trying to learn the ins and outs related to tax strategy. I do not want to hire an advisor to help with these things. I'd prefer to understand it myself!

mrmoneygoatee

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Re: Early Retirement Investing - Tax Strategies
« Reply #1 on: February 24, 2012, 10:44:40 AM »
So I found a similar thread called "Investing for the MMM Lifestyle": http://www.mrmoneymustache.com/forum/ask-a-mustachian/investing-for-the-mmm-lifestyle/

I am now reading http://www.bogleheads.org/wiki/Principles_of_Tax-Efficient_Fund_Placement and more on Rule 72(t).

Any other insight is appreciated.

AJ

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Re: Early Retirement Investing - Tax Strategies
« Reply #2 on: February 24, 2012, 11:36:45 AM »
We are currently maxing out our 401k(s) for the tax break (we're in the 25% bracket, and plan to be in 10-15% in retirement) with the intention of taking 72(t) distributions. You can also withdraw your Roth contributions without penalty. My plan/suggestion is to max out your tax-advantaged accounts before saving in a post-tax account (assuming your 401(k) has decent investment options). We are putting all our savings above the 401(k) and Roth into a regular savings account to go toward buying rental properties. Between the combined $44k we contribute to retirement accounts, and the $25k toward rental properties, we don't have anything leftover for taxes to touch. We could even push the real estate saving up to $50k per year before I would consider putting money into after-tax brokerage accounts. YMMV.

Chris

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Re: Early Retirement Investing - Tax Strategies
« Reply #3 on: February 24, 2012, 09:33:41 PM »
Honestly, I'd just like to invest my money is several diversified index funds across stocks and bonds, and not pay gains taxes until after I begin using the money after 43. Is this possible? Or will I always be paying gains taxes as the interest is reinvested no matter what path I take?

With mutual funds, you can get hit with capital gains tax even if you just follow a buy-and-hold strategy. So if the fund manager sells any of the holdings, the fund may be required to distribute that gain to the fund holders in that tax year. With exchange-traded funds (ETFs), you generally will only realize capital gains when you sell (or if the index the ETF is tracking changes its composition).

For distributions, you will pay tax on these regardless of whether you reinvest or not. The exception would be certain bond funds: you can avoid some/all taxes on interest earned from federal, state, and municipal bond funds. Interest on federal bonds isn't taxed at the state level, and state-issued bonds are generally not taxed on any level. Note that if you buy a bond ETF and sell it for a higher price, you will still have a capital gain; only the interest has preferential tax treatment.

Alfredya

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Re: Early Retirement Investing - Tax Strategies
« Reply #4 on: June 08, 2012, 05:22:23 AM »
I'm not really informed concerning retirement related topics, but when I feel a little bit lost I always check some websites about tax. eg I found this one about retirement plan distributions! Maybe it's helpful for you? It's so difficult to gather all the information together which is needed! :( but well.. better informing beforehand than nothing can go wrong!

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #5 on: June 08, 2012, 08:04:02 AM »
if someone could point me to a solid book or site to get started, that would also be lovely.
Stick around the MMM forums and you'll get some good general tips. Wikipedia has many great pages, such as this overview of 401k and IRA rules. Bogleheads wiki is great for investing advice. I'll spare you more links because there are plenty further on in my post.

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I currently put 7% of my income in pre-tax 401k through my company. This gives me their full match (3.5%). I project to have $400k in this account by 43 and $1.5MM by 65 if I cease contributions at 43 and earn 6% interest after that. This is enough to fund post-65 retirement, and I also should get a very healthy pension, so I don't wish to contribute more to accounts that I can't access until 65.
You can take early distributions called Substantially Equal Periodic Payments (SEPPs) from a 401(k) by following IRS rule 72(t). Plug your numbers into an SEPP calculator like this one to get an idea what sort of income your account could provide with that method.

Alternately, you can convert your 401(k) to a Roth IRA in the year in which you leave employment. Roth IRA principal can be withdrawn at any time without the 10 percent penalty, but if it comes from another retirement account you'll have to let it season in the account for 5 years first. If you choose this method, you'll have more access to and flexibility with your savings than if you take 72(t) distributions, but you'll have to come up with a way to fund the five years between when you retire and when your 401(k) money is fully seasoned.

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I plan to save >$25k/year above and beyond mortgage (3.5%), 401k, Health Savings Account, Daycare Flex Spending, 529 College Savings, and Student Loan (3.875%) payments.
If you find one of the two 401(k) early access methods fits your situation, I would encourage you to up your 401(k) contribution to the maximum, $17,000. $5,000 more should go into an IRA, and since you're planning on retiring early that IRA should be a Roth. This will minimize your total tax burden: the least tax-advantageous investment is a regular brokerage or mutual fund account, like you would open with Vanguard or Fidelity, and if you're putting your money in tax-advantaged pots first (Roth IRA, 401k, mortgage paydown, student loan paydown), you bear the full tax burden on much less of your income.

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I project that I will make $30k/year interest on this extra investment after 14 years if I earn 6% return.

These are my basic plans. I realize that 6% may be a little optimistic, but that is how I did it for now. I can adjust things accordingly if I change that.
MMM (and much of the ER/FI community) suggests using a 4% SWR to adjust for inflation so that your buying power won't erode over time.

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My work's pre-tax 401k is through Fidelity. I can also contribute to a Roth or an after-tax option.
If by this you mean a Roth 401(k), that might be worth looking in to; Roth 401(k) money is easier to convert to a Roth IRA than traditional 401(k) money is.

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Honestly, I'd just like to invest my money is several diversified index funds across stocks and bonds, and not pay gains taxes until after I begin using the money after 43. Is this possible? Or will I always be paying gains taxes as the interest is reinvested no matter what path I take?
My eyes, they burn. But seriously... 401k and IRA money aren't affected by gains taxes. You only pay on the Roth accounts when the money goes in, and you only pay on traditional accounts when the money comes out. It's only for your last pot of money, the traditional brokerage account, that you've got to worry about capital gains taxes and taxes on your dividends (which I believe are taxes as regular income, not as capital gains, but that nugget is worth what you paid for it.) You can also arrange your funds in various accounts in order to be the most tax efficient, a topic that the Bogleheads wiki covers very well.

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Should I be contributing to a Roth, knowing I want benefits from this investment at age 43? I've heard there are loopholes for accessing this money without penalty. Is this true?
The only withdrawal penalties are on earnings, not principal, and there's a principle that you withdraw principal before earnings, so it's only after you've withdrawn all of your contributions that you have to worry about a penalty on withdrawals.

Let It Be

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Re: Early Retirement Investing - Tax Strategies
« Reply #6 on: June 08, 2012, 01:08:18 PM »
The Bogleheads wiki and forum are great sources for information and advice on investing.  One site that has good information specifically related to the tax implications of investing is http://fairmark.com/, which I found recommended on the Bogleheads forum.  Fairmark has a forum, too, if you have specific questions.

NICE!

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Re: Early Retirement Investing - Tax Strategies
« Reply #7 on: June 09, 2012, 09:28:28 AM »
So just to be sure, when I leave an employer or am fired and rollover my Roth 401(k) to my existing Roth IRA, all of that money/distribution/rollover will be considered CONTRIBUTIONS to the IRA and can be withdrawn in 5 years with no penalties? So essentially a great tactic to FI is to have a Roth 401(k) from an employer, leave and rollover to a Roth IRA? This way you get to use tax-efficient vehicles for the bulk of your savings while still having some of the flexibility or using tax-inefficient vehicles?

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #8 on: June 09, 2012, 10:20:05 AM »
That's the way I thought it worked at first, but rereading the bogleheads and wikipedia pages I can't find anything definitive either way. Now I'm not so sure...

velocistar237

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Re: Early Retirement Investing - Tax Strategies
« Reply #9 on: June 09, 2012, 09:24:43 PM »
I am now reading http://www.bogleheads.org/wiki/Principles_of_Tax-Efficient_Fund_Placement

According to that page, you can get a foreign tax credit on some international funds. Has anyone done this and found out how big of an impact it is?

Chris

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Re: Early Retirement Investing - Tax Strategies
« Reply #10 on: June 11, 2012, 10:07:29 AM »
According to that page, you can get a foreign tax credit on some international funds. Has anyone done this and found out how big of an impact it is?

It really depends on how high the foreign taxes are.

mrmoneygoatee

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Re: Early Retirement Investing - Tax Strategies
« Reply #11 on: August 02, 2012, 11:19:58 AM »
So just to be sure, when I leave an employer or am fired and rollover my Roth 401(k) to my existing Roth IRA, all of that money/distribution/rollover will be considered CONTRIBUTIONS to the IRA and can be withdrawn in 5 years with no penalties?

This is a great question. I did some quick research but couldn't find a definitive answer either. Does anyone know?

Hypothetically, let's say I am 35 and I've contributed $100k to a pre-tax 401k and it has earned $50k. After leaving the company, I can roll this $150k to a Roth IRA. It will all be taxed at that time at my current tax rate (which could be low if unemployed). Let's say the account is left with $120k after taxes.

So after 5 years has past, how much can I withdraw from the Roth IRA tax and penalty free? Is it $100k, $120k, or $0?

JohnGalt

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Re: Early Retirement Investing - Tax Strategies
« Reply #12 on: August 02, 2012, 11:25:37 AM »
So just to be sure, when I leave an employer or am fired and rollover my Roth 401(k) to my existing Roth IRA, all of that money/distribution/rollover will be considered CONTRIBUTIONS to the IRA and can be withdrawn in 5 years with no penalties?

This is a great question. I did some quick research but couldn't find a definitive answer either. Does anyone know?

Hypothetically, let's say I am 35 and I've contributed $100k to a pre-tax 401k and it has earned $50k. After leaving the company, I can roll this $150k to a Roth IRA. It will all be taxed at that time at my current tax rate (which could be low if unemployed). Let's say the account is left with $120k after taxes.

So after 5 years has past, how much can I withdraw from the Roth IRA tax and penalty free? Is it $100k, $120k, or $0?

If you follow that scenario - I believe you would be able to withdraw the full $120k tax and penalty free after 5 years.

The more efficient scenario, however, would be to only roll over 1 years worth of expenses that you will need 5 years later every year.  This way you keep your marginal tax bracket very low (say 10-15%) rather than going up to the higher bracket (25-28%) when you do it all at once. 

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #13 on: August 02, 2012, 11:28:12 AM »
After leaving the company, I can roll this $150k to a Roth IRA. It will all be taxed at that time at my current tax rate (which could be low if unemployed).
No, it is all taxed as income. If you make $20k that year, it will be added to your income and your taxable income for the year will be $170k. That means most of the money will be taxed in the 25% and 28% brackets. It's much better to roll over just as much as you'll need five years in the future (which would be like five years at $70k income instead of one year at $170k income and four years at $20k income)

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So after 5 years has passed, how much can I withdraw from the Roth IRA tax and penalty free? Is it $100k, $120k, or $0?
$100k.

mrmoneygoatee

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Re: Early Retirement Investing - Tax Strategies
« Reply #14 on: August 02, 2012, 11:34:11 AM »
Thanks a bunch.

I understand about the conversion amount being treated as "income" in that year and thus affecting tax brackets. That makes sense.

So JohnGalt says $120k (both 401k contributions and earnings are treated as Roth "contributions" after rollover) and grantmeaname says $100k (only 401k contributions are treated as Roth "contributions" after rollover).

I would expect the latter is the way it is. Otherwise, it would seem too good to be true. But does anyone have a source that explicitly spells this out?

Either way, this method seems way better to me than the 72(t) rule. Am I missing something?

sol

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Re: Early Retirement Investing - Tax Strategies
« Reply #15 on: August 02, 2012, 03:49:43 PM »
It's 100k. Only Roth principal contributions come out tax free, not earnings from within the Roth account.

The hitch with this plan is that not all plans allow a rollover every year. Some limit the number of times you can do the rollover, preventing you from building the give year pipeline. Read your plan literature.

JohnGalt

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Re: Early Retirement Investing - Tax Strategies
« Reply #16 on: August 02, 2012, 04:14:10 PM »
It's 100k. Only Roth principal contributions come out tax free, not earnings from within the Roth account.

The hitch with this plan is that not all plans allow a rollover every year. Some limit the number of times you can do the rollover, preventing you from building the give year pipeline. Read your plan literature.

How are earnings separated from contributions at this point?  Don't you pay taxes on the full $150k during the conversion leaving the $120k as fully after tax dollars when it goes into the Roth?  I'm not saying that you're not correct, it is tax code after all, I just don't follow the logic.  I always thought contributions could be withdrawn tax and penalty free because you've already paid taxes on that money where earnings were never taxed so they would be subject to both. 

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #17 on: August 02, 2012, 05:43:29 PM »
You should not move so much money that you have to withdraw from the Roth after conversion to pay your taxes. You'll then pay the taxes on it twice and pay a 10% tax penalty. If you're in the 28% bracket that means you're paying 66% tax on it.

jawisco

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Re: Early Retirement Investing - Tax Strategies
« Reply #18 on: August 02, 2012, 07:51:08 PM »
I would not call myself an expert, but I think John Galt is correct about the conversion number. 

At the time of conversion from 401K to Roth IRA, you pay income tax on the total amount moved from 401K to Roth IRA - this number is now your Roth IRA contribution - available for withdrawal in 5 years.

sol

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Re: Early Retirement Investing - Tax Strategies
« Reply #19 on: August 02, 2012, 08:24:34 PM »
How are earnings separated from contributions at this point?

When you move money from the 401k to the Roth, the part that is contributions vs earnings doesn't matter.  You'll pay taxes on the full conversion amount as income.  It's generally best to move the full amount over, and pay the taxes separately from other sources.

Once the money is in your Roth, it is all contributions.  It will sit in the Roth and season for five years and accrue additional earnings.  After five years, you can take out all of the rollover amount as Roth contributions without penalty or additional taxes.  Whatever new earnings you've made during the 5 year seasoning period is still off limits until retirement age.


JohnGalt

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Re: Early Retirement Investing - Tax Strategies
« Reply #20 on: August 02, 2012, 08:42:28 PM »
How are earnings separated from contributions at this point?

When you move money from the 401k to the Roth, the part that is contributions vs earnings doesn't matter.  You'll pay taxes on the full conversion amount as income.  It's generally best to move the full amount over, and pay the taxes separately from other sources.

Once the money is in your Roth, it is all contributions.  It will sit in the Roth and season for five years and accrue additional earnings.  After five years, you can take out all of the rollover amount as Roth contributions without penalty or additional taxes.  Whatever new earnings you've made during the 5 year seasoning period is still off limits until retirement age.

That was my thinking... so why would it be $100k instead of $120k?  The $50k in earnings were earned in the 401k, not the roth.

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #21 on: August 03, 2012, 06:45:05 AM »
Quit using the $120k number! It's wrong.

If you have to withdraw from your retirement account to pay the conversion taxes, you'll be paying 1) income tax on the entire sum; 2) income tax again on the part you withdrew early; 3) 10% penalty tax on the part you withdrew early.

That means if you're paying taxes out of your contribution, you need $42k to cover 1. That's $67.7k after you count in 2 and 3. That means your real after-tax number would be $82.3k. Hopefully the magnitude of the difference is enough that it's clear why that's not how you would want to go about things.

Do not move so much in one year that you have to dip into your retirement savings to pay the income tax on it.

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #22 on: August 03, 2012, 06:54:32 AM »
As for the main question, whether traditional 401(k) funds rolled over to a Roth IRA retain their 'contributions' or 'earnings' nature when moved:
It seems like Roth 401(k) funds retain their 'contributions' or 'earnings' nature when moved into a Roth IRA. There's not much of anything about the question on personal finance blogs, and I don't remember seeing anything of the sort last time I searched through the Bogleheads forum, so I spent a little time yesterday digging through the relevant IRS publication (590). I haven't found anything definitive either way, yet.

JohnGalt

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Re: Early Retirement Investing - Tax Strategies
« Reply #23 on: August 03, 2012, 08:40:45 AM »
Quit using the $120k number! It's wrong.

If you have to withdraw from your retirement account to pay the conversion taxes, you'll be paying 1) income tax on the entire sum; 2) income tax again on the part you withdrew early; 3) 10% penalty tax on the part you withdrew early.

That means if you're paying taxes out of your contribution, you need $42k to cover 1. That's $67.7k after you count in 2 and 3. That means your real after-tax number would be $82.3k. Hopefully the magnitude of the difference is enough that it's clear why that's not how you would want to go about things.

Do not move so much in one year that you have to dip into your retirement savings to pay the income tax on it.

What is wrong about the $120k?  He clearly stated that the starting point was $150k and assumed that $120k was left after taxes to be rolled into the roth IRA.  I'm just going with his assumption rather than trying to calculate the actual tax amount.

In any case - we are in agreement on the end result - that it is a bad idea to convert the entire account at once. 

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #24 on: August 03, 2012, 09:20:34 AM »
The part that's wrong is his assumption that you should ever withdraw from the account to pay your taxes. That's what I'm trying to point out. Your logic and your argument are fine, but the entire conversation is based on a flawed premise.

velocistar237

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Re: Early Retirement Investing - Tax Strategies
« Reply #25 on: August 03, 2012, 09:23:03 AM »
It seems like[/url] Roth 401(k) funds retain their 'contributions' or 'earnings' nature when moved into a Roth IRA. There's not much of anything about the question ...

Is this article definitive enough?

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #26 on: August 03, 2012, 09:55:18 AM »
It's more definitive than a Bogleheads forum post, yes. (Even if it weren't, a Bogleheads forum post was definitive enough for me...) I'll be keeping that link around.

We're trying to answer the same question for a traditional 401k, though, not a Roth 401k. That's what I've been having trouble finding.

velocistar237

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Re: Early Retirement Investing - Tax Strategies
« Reply #27 on: August 03, 2012, 10:28:26 AM »
How about this?

Quote from: Motley Fool
Penalties on Conversions From a Traditional IRA to a Roth IRA

The penalty rules regarding conversions are a bit different than those for annual contributions, which may be taken at any time for any purpose free of income taxes and penalty. An early withdrawal of a conversion contribution has a different twist. The early withdrawal penalty applies to a distribution of conversion money from a Roth IRA when:

1. The distribution is made within the five-tax-year period starting with the year that the conversion was distributed from a regular IRA; and
2. Only to the extent that the distribution is attributable to amounts that were includable in gross income as a result of the conversion.

There is no mention of contributions and earnings. According to the above, if you satisfy the 5-year period, the early withdrawal is penalty free.

It might be difficult to find something explicitly saying that there is no distinction between contributions and earnings in the Traditional 401k, if it's simply a foreign concept.

jawisco

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Re: Early Retirement Investing - Tax Strategies
« Reply #28 on: August 03, 2012, 11:15:10 AM »
Quit using the $120k number! It's wrong.

If you have to withdraw from your retirement account to pay the conversion taxes, you'll be paying 1) income tax on the entire sum; 2) income tax again on the part you withdrew early; 3) 10% penalty tax on the part you withdrew early.

That means if you're paying taxes out of your contribution, you need $42k to cover 1. That's $67.7k after you count in 2 and 3. That means your real after-tax number would be $82.3k. Hopefully the magnitude of the difference is enough that it's clear why that's not how you would want to go about things.

Do not move so much in one year that you have to dip into your retirement savings to pay the income tax on it.


This is not correct.  You do not pay income tax twice on the money used to pay income taxes...

When you take $ out of 401K, you pay income tax on this whole amount.  The $ that will be rolled over to a Roth IRA does not pay a penalty.  The $ that is used to pay income taxes will pay a 10% penalty for early withdrawal.

Ex) You withdraw 150K from 401K and are in the 25% tax bracket with all this money.  You will owe $37,500 in income taxes.  If you use your 401K money to pay the income tax, you will need to use around $42.5K to allow you to pay the $37.5K in income taxes and 10% penalty on 42.5K (which is $4,250).  This is quick round numbers but essentially correct.  This scenario would leave you with $107.5K to roll over into your Roth IRA from your original 150K. 

There are various strategies to pay less in taxes and make the conversion over more time, and they are worth investigating, but you definitely can pay your income taxes out of your 401K money and not be paying income tax twice...

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #29 on: August 03, 2012, 11:46:46 AM »
Withdrawing from a traditional 401(k)/IRA to pay taxes is not the same thing as a rollover from the traditional account to a Roth IRA. It's not like you just withdraw the money and then out of the goodness of its cold bureaucratic heart, the IRA waives the $5,000 contribution limit for you. Rollovers and withdrawals are totally distinct things, and I think you're confusing them.

You could either 1) calculate your tax liability for the rollover, then withdraw a sufficient amount from your traditional account before the rollover in order to pay the taxes for its own withdrawal and the rollover (then yes, technically, this method satisfies your last criterion, but note that the money withdrawn and the money rolled over are in two separate pots), or 2) move everything, then withdraw from your Roth IRA a double-income-taxed and tax-penaltied sum sufficient to pay for the rollover cost plus all its own penalties. Alternately, 3), you could be intelligent about it and roll over slowly in order to minimize your tax burden, and ensure that you don't have to withdraw from your retirement funds in order to move them.

jawisco

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Re: Early Retirement Investing - Tax Strategies
« Reply #30 on: August 03, 2012, 08:03:21 PM »
I have not converted a 401K into a Roth IRA, but I have done a conversion from TIRA to a Roth, and they do just give you the money(or check rather) and you have a certain amount of time to roll it over.  You can rollover as much as you want to and you pay a penalty on the balance.  There aren't any pots really.

I don't believe you can ever be double-income taxed no matter what you do.  If you withdrawal rollover money before the 5 years has passed, you will owe the 10% penalty only.  If you withdrawal earnings before the 5 year mark, only then will you owe 10% penalty AND income tax.  At least that is the way I understand the rules...

I agree that a slow roth conversion is a good idea - especially if you live frugally - it is what I plan to do in the coming years as I slip into a lower tax bracket.  But there are some arguments for doing it fast as well - especially if you do a self-directed Roth.  Sure, you pay a lot in taxes when you do it lump sum, but you also get all those years for that $ to compound tax free and if you do a self-directed and believe you can make better returns than the extra you pay in initial taxes, then it might make sense to do lump sum even if you have a large initial tax bill. 

Somebody better at math than I am can probably figure out what ROI you would need in order to make converting at 25% tax bracket worth it compared to 15%...

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #31 on: August 04, 2012, 08:02:14 AM »
I don't believe you can ever be double-income taxed no matter what you do.  If you withdrawal rollover money before the 5 years has passed, you will owe the 10% penalty only.
That's how I would've thought it worked, too. But alas, no. "Early withdrawal that is more than contributions plus seasoned conversions are subject to normal income taxes and 10% penalty if not qualified distributions" -Wikipedia

jawisco

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Re: Early Retirement Investing - Tax Strategies
« Reply #32 on: August 16, 2012, 03:30:53 PM »
I don't believe you can ever be double-income taxed no matter what you do.  If you withdrawal rollover money before the 5 years has passed, you will owe the 10% penalty only.
That's how I would've thought it worked, too. But alas, no. "Early withdrawal that is more than contributions plus seasoned conversions are subject to normal income taxes and 10% penalty if not qualified distributions" -Wikipedia

That quote is confusing and not clear - at least to me.

When I read the IRS page - http://www.irs.gov/publications/p590/ch02.html#en_US_2011_publink1000231076 - and look under "Additional Tax on Early Distributions" it appears to me that there is no income tax on rollover amounts taken out earlier than 5 years after the rollover - only the 10% penalty.  See the paragraph about what part of unqualified distributions should be included in your income...

Another source - http://moneyover55.about.com/od/iras/a/rothirawithdrawal.htm - has this clear example:

Under What Circumstances Would I Pay Tax On A ROTH IRA Withdrawal?

If you are under age 59 1/2, and you are withdrawing more than the total of all of your original contributions, then the portion of your withdrawal that is investment gain would be subject to income taxes and a 10% penalty tax.
If you have funds in your ROTH IRA that were converted from a traditional IRA or rolled into your ROTH from a qualified retirement plan, and it has been less than five years since the conversion or rollover, any conversion amounts withdrawn would be subject to a 10% penalty tax, even though they would not be subject to ordinary income taxes. Any investment gain attributed to those conversion amount would be subject to ordinary income taxes and the 10% penalty tax.
The five year clock is measured from the first day of your tax year in which you convert an amount from a traditional IRA or rollover an amount from a qualified retirement plan.
Example:

John has $20,000 in his ROTH IRA.
$10,000 of it came from his original contributions.
He made his first contribution over five years ago.
Last year he converted $8,000 from a traditional IRA to his ROTH.
$2,000 of his ROTH is from investment gains.
John is age 58.
John cashes in his entire ROTH IRA.

On the first $10,000 of withdrawal, he pays no tax, since he is withdrawing his original contributions.
On the next $8,000 of withdrawal, he pays a 10% penalty tax since it has been less than five years since the conversion.
On the last $2,000 of withdrawal, which is all investment gain, he pays income tax and a 10% penalty tax.

NestEggChick (formerly PFgal)

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Re: Early Retirement Investing - Tax Strategies
« Reply #33 on: August 16, 2012, 04:46:28 PM »
This is a great topic.  I don't have anything to contribute; I'm just commenting so I can be notified of replies.  Sorry for the comment clutter!

arebelspy

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Re: Early Retirement Investing - Tax Strategies
« Reply #34 on: August 16, 2012, 07:04:06 PM »
This is a great topic.  I don't have anything to contribute; I'm just commenting so I can be notified of replies.  Sorry for the comment clutter!

At the bottom of the thread, next to the "reply" button (not quick reply), do you have a "notify" button? 

(Not sure if you do, cause I have a few moderator options next to that, but just checking in case.)

If so, that would let you be alerted without posting.  However do feel free to post, even a "this is a great topic" is helpful as it can encourage others to continue contributing.
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JohnGalt

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Re: Early Retirement Investing - Tax Strategies
« Reply #35 on: August 16, 2012, 07:10:59 PM »
This is a great topic.  I don't have anything to contribute; I'm just commenting so I can be notified of replies.  Sorry for the comment clutter!

At the bottom of the thread, next to the "reply" button (not quick reply), do you have a "notify" button? 

(Not sure if you do, cause I have a few moderator options next to that, but just checking in case.)

If so, that would let you be alerted without posting.  However do feel free to post, even a "this is a great topic" is helpful as it can encourage others to continue contributing.

We all have the notify option at the bottom - but I have noticed a few posts where people have just said they were posting to get notifications. 

I will say, I don't like the email notify so much - but I do like the link that lets me just see new replies to my posts.  Maybe that's where they're trying to add it to?

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #36 on: August 17, 2012, 08:02:21 AM »
Again, distributions are only qualified for those over 59.5 except for educational expenses, first-time homebuyers, medical expenses, or hardship withdrawals. This is not any of these, so I think it's just a withdrawal and not a distribution, and that all doesn't apply. That's why I'm having so much trouble finding anything in the IRS literature: they don't really delineate between these clearly.

jawisco

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Re: Early Retirement Investing - Tax Strategies
« Reply #37 on: August 17, 2012, 09:28:03 PM »
Withdrawal is just another word for distribution.  Any time money comes from an IRA, it is called a distribution - it is either a qualified distribution(no penalty or taxes) or it is unqualified distribution (where you would owe a penalty and possibly need to declare the distribution under your income if it is investment gains).  At least that is how I understand it...

I don't believe the IRS ever makes you pay income tax on the same money twice - at least I can't think of a situation.

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #38 on: August 18, 2012, 07:49:55 AM »
Withdrawal is just another word for distribution.  Any time money comes from an IRA, it is called a distribution - it is either a qualified distribution(no penalty or taxes) or it is unqualified distribution (where you would owe a penalty and possibly need to declare the distribution under your income if it is investment gains).  At least that is how I understand it...
I don't think so, which is what I've been trying to say all this time. Anyone can take money out of their Roth IRA at any time, and it's not a qualified distribution, but it's not taxed, so it also must not be an unqualified distribution. That makes it not a distribution, right?

jawisco

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Re: Early Retirement Investing - Tax Strategies
« Reply #39 on: August 19, 2012, 08:07:28 PM »
I might be in over my head...

Any experts out there who can shine some definitive light on these questions?

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #40 on: August 20, 2012, 05:53:46 AM »
We need to attract a CPA. Maybe we could offer free cookies.

Chris

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Re: Early Retirement Investing - Tax Strategies
« Reply #41 on: August 20, 2012, 09:13:29 AM »
I don't think so, which is what I've been trying to say all this time. Anyone can take money out of their Roth IRA at any time, and it's not a qualified distribution, but it's not taxed, so it also must not be an unqualified distribution. That makes it not a distribution, right?

Getting money out of an IRA is a distribution. It you're only taking out contributions, it should be noted in box 1 of your 1099R, with an empty box 2a (earnings).

Anyone can take money out of their Roth IRA under certain conditions, without paying a tax penalty. One of those conditions a withdrawal of contributions..... but only after the 5-year holding period.  Additionally, even if you can withdraw without a tax penalty, your IRA administrator may charge a fee for any pre-59.5 distribution. 

Roth IRAs are great, but you can't just use it like a bank account.

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #42 on: August 20, 2012, 03:31:07 PM »
You don't need to wait five years to withdraw your Roth IRA direct contributions. That's only with rollovers and conversions.

Chris

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Re: Early Retirement Investing - Tax Strategies
« Reply #43 on: August 20, 2012, 04:27:10 PM »
You don't need to wait five years to withdraw your Roth IRA direct contributions.

Yes. Got a source for it too.

The flowchart, such a distribution would fail the first box (5-year limit), making it a non-qualified distribution.  To determine the amount subject to tax, complete form 8606 part III. Enter the distribution amount and subtract all contributions, leaving the taxable amount at zero.

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #44 on: August 20, 2012, 05:00:23 PM »
Yeah, I've seen and linked that document too. It would be more helpful to link to the part of the document that you think supports your assertion than its entirety.

Check out this part. In the bottom right of the flowchart: even a distribution that is unqualified can only be taxed on the portion not attributable to contributions. That means at any time you can withdraw up to your entire basis, with no penalty. Or, in other words, yes, you could use it as a savings account.

Mirwen

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Re: Early Retirement Investing - Tax Strategies
« Reply #45 on: August 20, 2012, 11:08:55 PM »
I'm not a CPA, just a tax advisor, but it seems you don't need to offer cookies.  You know about as much as most tax advisors.  The secret is knowing where to look up the info and knowing how to read IRS's unique language style.

Yeah, you can withdraw contributions at any time without penalty, the 5 year only applies to conversions.  You don't need me.  Carry on.

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #46 on: August 21, 2012, 06:26:48 AM »
knowing how to read IRS's unique language style.
That's the tough part. It seems I need to come up for air before I get anything meaningful out of most of their publications.

StetsTerhune

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Re: Early Retirement Investing - Tax Strategies
« Reply #47 on: August 28, 2012, 06:23:17 PM »
This is a great topic, glad I found it.  Confirmed a lot of things I'd been thinking and planning on. Some similar things above, so sorry if part of this is repetitive.

I currently have about 20K in my Roth IRA and 100K in my 401K. In a few years, when I (hopefully) have no income,  I'll convert my 401K to a regular IRA. Then as the years go by, I'll annually convert small amounts of the regular IRA into the Roth IRA, optimizing based on other income to pay as little tax as possible.  Long before I hit 59.5, I'll probably run out of non IRA assets and have to start withdrawing money from the Roth IRA, but will hit 59.5 before I need to withdraw more than my original contributions, and thus pay no penalties or additional taxes. Assuming this all works as I understand it, there is absolutely no penalty at all for "overcontributing" to retirement accounts, as OP seems to think. Is this all correct/a reasonable summary of all the knowledge that came before me on this post?

grantmeaname

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Re: Early Retirement Investing - Tax Strategies
« Reply #48 on: August 29, 2012, 03:11:04 PM »
What do you mean by overcontributing?

StetsTerhune

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Re: Early Retirement Investing - Tax Strategies
« Reply #49 on: August 29, 2012, 05:35:48 PM »
OP seems to be under the impression that if the money in retirement accounts is locked up till 59.5, then it's possible to contribute more money to retirement accounts than you'll need post that age, and not have enough money leftover in taxed accounts to pay for early retirement. This is what I mean by "overcontribute." which, based on my understanding, shouldn't be an issue.