Considering drawing down the 401(k) in 2020

[Paul der Krake]

Idea:

Draw down 20-30k of living expenses from the pre-tax bucket in 2020 instead of selling assets in taxable.

Facts:

1) The CARES Act removed the 10% penalty for the year.
2) I'd be selling bonds in pre-tax as part of normal rebalancing operations, so the tax-free growth over the next 30 years isn't worth that much.
3) My pre-tax accounts represent 2/5 of my assets, which I think is larger than I would like.

Thoughts?

[Mr. Green]

Idea:

Draw down 20-30k of living expenses from the pre-tax bucket in 2020 instead of selling assets in taxable.

Facts:

1) The CARES Act removed the 10% penalty for the year.
2) I'd be selling bonds in pre-tax as part of normal rebalancing operations, so the tax-free growth over the next 30 years isn't worth that much.
3) My pre-tax accounts represent 2/5 of my assets, which I think is larger than I would like.

Thoughts?

I think I read that you have to meet one of several different criteria showing COVID directly impacted you, like you got it or lost a job because of it. Would you meet one of those criteria?

[Mr. Green]

Assuming you qualify to make the early withdrawal, I'm struggling to see a downside. We'd take every opportunity we could to get money moved from a tIRA into more tax advantaged accounts. If you're much younger than 60, being able to move that money to a brokerage account is a big improvement over a Roth IRA because you won't have to wait 5 years to access the funds and you can access the gains as well, not just the principal. Though with the Roth IRA you get to avoid paying capital gains taxes. That benefit only applies if you're in a high enough tax bracket that your long term capital gains taxes would be above 0%.

[terran]

1) This isn't entirely true. As @Mr. Green says,  If you were effected by COVID in a list of ways then there's no penalty. The article goes beyond straight withdrawals, but you can find this information and more here: https://www.kitces.com/blog/corona-virus-related-distributions-unwanted-rmd-cares-act-rollover-in-service-early-distribution-penalty/
2) This isn't really relevant. You can sell bonds in your 401(k) and withdraw, or you can sell stocks in taxable to spend and exchange bonds for stocks in your 401(k). Either option can get you to your desired asset allocation.
3) That could be a good reason to withdraw from a 401(k). Although, a better option might be to convert some of the 401(k) to Roth (you might have to roll over to an IRA first to do this) while continuing to spend from taxable. This is the natural extension of the Investment Order sticky at the top of the investments forum in that it results in more money in tax advantaged and less in taxable while still taking advantage of lower tax brackets. You should probably be doing this regardless of the special CARES act rules to the extent possible while considering tax brackets and ACA subsidies (if applicable).

[Paul der Krake]

Good callout on the qualification requirements. Naively I thought that anybody holding stonks could say they were impacted and qualify, but I now see it's a little more fine-grained.

For the purpose of the discussion though, let's say my (very) small business has been hurt, and assume I qualify.

Something else I just thought about: unless Congress extends the provision, this strategy is really just a one time thing. If I go for it in 2020, I basically just reduced my pre-tax account by about 10%. Not exactly earth shattering.

[terran]

It's sort of a one time thing, except the taxes can be spread out over 3 years, so you could make it a 3 time thing by withdrawing what you need for 3 years and then paying the taxes over those three years. I wouldn't risk it though. It's easy enough getting money out of a 401(k) without having to hope that you can get away with saying you were effected by COVID.

Why aren't you doing Roth conversions? Presumably you have enough to live off of in taxable for the next 5 years, so why not get a Roth conversion ladder going and then you'll have access to this money without penalty in 5 years anyway.