Author Topic: Confused about 401k withdrawals  (Read 4179 times)

lvap

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Confused about 401k withdrawals
« on: July 14, 2014, 10:47:49 AM »

Hi All!
I’ve been reading up on FI for the last several weeks, but I seem to be missing a big piece of the puzzle. Forgive my ignorance, but can some explain how this works?

If you retire at 40, but aren’t “supposed to” withdraw funds from your 401k until age 55, where do your living expenses come from between 40-55yrs old? Do you just take the hit on penalties during that time? Am I missing a huge piece of information? Your help is appreciated!

Cheddar Stacker

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Re: Confused about 401k withdrawals
« Reply #1 on: July 14, 2014, 10:53:45 AM »
Do you just take the hit on penalties during that time? Am I missing a huge piece of information?

No, and yes, respectively.

Unless there is some crazy hair on fire emergency, don't pay a 10% penalty on your 401K. It's just a killer. Even if there is an emergency you should try avoid that.

There are 2 basic ways discussed here a lot:

1) SEPP - Substantially equal period payments. It's also referred to as rule 72t. In summary, you take a certain amount (within the IRS rules) each year and it can't be changed until you're 60. The number starts at around 2-3% of your portfolio value.
2) Roth conversion pipeline. You convert your 401k's to IRA's when you quit, then each year you convert some funds from IRA to Roth IRA. You pay tax on the amount converted. After 5 years you can withdraw these funds tax/penalty free.

It's important to also look into ways to supplement your income during the first 5 years, or between 40 and 60 if you want to leave the retirement funds alone. Many people suggest a 3 pronged attack:

1) Save everything you can into tax deferred accounts.
2) Save the max into Roth IRA's.
3) Save any excess into a taxable brokerage account which you can draw down during the first x years of retirement.

Cheddar Stacker

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Re: Confused about 401k withdrawals
« Reply #2 on: July 14, 2014, 10:56:05 AM »
Also, here is some standard reading that explains this strategy a little within a lot of great advice.
http://www.madfientist.com/retire-even-earlier/

MooseOutFront

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Re: Confused about 401k withdrawals
« Reply #3 on: July 14, 2014, 11:11:53 AM »
Cheddar has answered your question very well, but I'll add some just because it's a fun topic.

Any Roth IRA contributions can be taken out tax free at any point in the future.  The 5 year waiting period he referred to only applies to money rolled over into a Roth.

For example our plan includes having about $120k in Roth contributions and about $50k in taxable to spend down in addition to part time self employment to get us through those 1st 5 years of retirement before the annual Roth rollovers start becoming available. 

Cheddar Stacker

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Re: Confused about 401k withdrawals
« Reply #4 on: July 14, 2014, 12:41:44 PM »
Cheddar has answered your question very well, but I'll add some just because it's a fun topic.

Any Roth IRA contributions can be taken out tax free at any point in the future.  The 5 year waiting period he referred to only applies to money rolled over into a Roth.

For example our plan includes having about $120k in Roth contributions and about $50k in taxable to spend down in addition to part time self employment to get us through those 1st 5 years of retirement before the annual Roth rollovers start becoming available.

Good points Moose, and just for a little more clarification for the OP, Roth contributions can be withdrawn at any point without tax/penalty, earnings on those contributions can't be taken out until 59.5 without penalty.

lvap

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Re: Confused about 401k withdrawals
« Reply #5 on: July 14, 2014, 12:59:59 PM »
Thank you! I will start reading up on that link.

So I think my "real" questions is this. I have PERS (Public Employee Retirement). I also have a 403b which I just started putting money into. If I have a limited amount of money, say $2000/month to save/invest. Where should it go? Roth IRA? Traditional IRA? 403b?   All of the advice I've read so far says that you should max out your retirement accounts yearly and afterwards invest in index funds. I'm not sure I'll be able to get to the index funds part if I'm trying to max out both a 403b and a Roth.

If I'm looking at this correctly, I could be throwing $ into 403b and then convert living expenses over to Roth when I "retire"? 

Ohhh...I'm slowly starting to get it. So if I personally contribute $250,000 to Roth, I can take $250,000 without penalty--just not the earnings?

Thank you for your patience! I'm new to this :) I wish they taught this stuff to everyone!

Cheddar Stacker

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Re: Confused about 401k withdrawals
« Reply #6 on: July 14, 2014, 01:23:51 PM »
...If I have a limited amount of money, say $2000/month to save/invest. Where should it go? Roth IRA? Traditional IRA? 403b?   

Check the expense ratios on your investment options within the 403b to make sure you aren't getting killed. Even if you are, this is likely your best place. If there is an employee match on this, make sure you contribute enough to max that out. Putting it in a 403b reduces your taxable income which opens up doors. If you don't first put it into the 403b, you might not be eligible for a Roth Ira (or traditional IRA).

I would go 403b, then TIRA, then taxable brokerage, but it depends on your income and other specific circumstances. Many others here would say Roth IRA instead of TIRA. You have to choose what works best for you.

Ohhh...I'm slowly starting to get it. So if I personally contribute $250,000 to Roth, I can take $250,000 without penalty--just not the earnings?

Thank you for your patience! I'm new to this :) I wish they taught this stuff to everyone!

Correct, if you contribute directly. If the Roth was contributed via a rollover from a TIRA you have to wait 5 years to access the contributions.

This stuff is taught/learned/experimented with here daily, you just had to find this place first. I'm glad you did, and I'm glad I did too. Good luck!

Lis

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Re: Confused about 401k withdrawals
« Reply #7 on: July 14, 2014, 03:36:40 PM »
I'm with Ivap on this - this topic has always confused me. Ivap, thanks for posting it! And Cheddar, thanks for the information and the link you provided! Super helpful!!