Do you hesitate using 401(k) money because of taxes?

C50

C50

Senior Member
Location
Ohio, USA
I didn't fully realize the tax implications 401(k) money or capital gains would have on my Social security benefits, I knew there would be tax but didn't realize the full implications.

I am right at the edge that with no other income my SS benefits aren't taxed, but it doesn't take much to be at 85% of my benefits being taxed. And there's also the concern of pulling too much money in one year and having your Medicare cost increased. I now realize if I want to spend a chunk of money it's not as simple as pulling investment money, there's lots of financial strings attached. It feels like I get punished for all those years of being financially prudent.

So is it just me? Have others found they had to scale back retirement plans even though they have the money?
 

Wait until you get to RMD age. By law, I have to withdrew a certain percentage of my IRA each year. This pushes me to be taxed on 85% of our Social Security and hit with an IRMAA increase in my Medicare payments. It also puts me in a higher tax bracket.
 

Yep, we have already been down this road. You are correct. But you have to recall that your withheld earnings that went into your 401K were untaxed earnings. In theory, you avoided taxes on that money hoping that your tax rate would be lower when you retired. But in the end eventually you have to pay up...

On your SSI, that money also, usually (self-employed?) paid by your employer, has never been taxed. Being able to use it untaxed is set aside for those who have NOTHING else to draw from. So, if you must draw from your SSI manage it as best you can.

Our Tax Strategy
We downsized our home and had a net gain that was fully taxed. We put that cash into a money market, primarily as emergency money. Over the years we never needed any of it, so we started using it to supplement our income when needed/wanted money for something that could not be drawn from our 401k without impacting our taxability on our SSI. This has worked fairly well so far...

We have a budget that we follow, it protects our SSI from going to highly taxed state....if we need more we hit our cash MM

Bottom line we manage our income, as we did before retirement. We know if we decided to take a big trip or something that we will just go for it and take the tax hit. We are now well into our retirement and have limited fear of running out of money, disregarding the state of the stock market right now, as we believe in time it will recover...
 
I get that my 401(k) was pretax dollars and fully expected to be taxed on that money. It's just I feel like a dog chasing its tail trying to manage the total tax ramifications I hadn't realized. I had a certain dollar amount I planned to live on with the ocassional larger draw to cover large expenses, but I have to rethink that strategy. I feel I almost need to draw money on a yearly basis and move to cash even if I don't need it, just to try and minimize taxes.

I do have a decent cash reserve to draw on but but overall my financial plan isn't going to unfold how I had hoped, and as I planner it bothers me I missed some important issues.
 
I've been paying "taxes" on my IRA withdrawals for nearly 20 years, now. We get our SS, and I have a defined pension plan from my working years, and we get a monthly payment from the IRA....so we have 3 reliable sources of income. Personally, I am glad we get enough to have to pay taxes....instead of stressing over every unexpected expense that might come up.
 
Talk to your accountant or tax preparer.

Mine urges his clients to contact him in early December so he can run an estimate of how much they can draw before the year-end without triggering a significant tax increase.

I took a draw before I qualified for SS benefits, but now I would lose approx. 20% to taxes so I stopped.

If you need to take a reasonable draw in order to live comfortably then take it and don't begrudge the taxes.

Good luck.
 
One thing I do to reduce my taxable income is to do QCD;s (Qualified Charitable Donations) from my IRA. This basically means that it only costs me 70 cents for every dollar donated.
 
C50 said:
I didn't fully realize the tax implications 401(k) money or capital gains would have on my Social security benefits, I knew there would be tax but didn't realize the full implications.

I am right at the edge that with no other income my SS benefits aren't taxed, but it doesn't take much to be at 85% of my benefits being taxed. And there's also the concern of pulling too much money in one year and having your Medicare cost increased. I now realize if I want to spend a chunk of money it's not as simple as pulling investment money, there's lots of financial strings attached. It feels like I get punished for all those years of being financially prudent.

So is it just me? Have others found they had to scale back retirement plans even though they have the money?
Click to expand...
I have been learning about this too since I retired this year. I wish I'd learned about money and retirement a long time ago, I didn't understand about Roth IRAs, and also the past few years when I'd learned about traditional IRAs I needed the tax deduction of the contribution in order to have money to contribute. But there were a couple years several years ago when I was making a better income and wanted to contribute more but didn't know the value of the 401k contributions (I'd only ever heard about make enough contribution to get company match, but the company had no match and I didn't understand I'd have less taxes just from contributing anyway, I was so sadly ignorant!).

Apparently the correct way to have prepared for retirement taxation is to have saved part of your retirement money in a traditional IRA and part of your money in Roth IRA, then the RMDs from the traditional would be less and the Roth IRA money could be used to avoid tipping over the income line that causes higher IRMAA thingy.

If you have a lot of money, and you are young enough to have more than 10 years ahead of you, then a lot of people recommend doing conversions from traditional IRA to roth IRA up to a particular income bracket. It is all too complicated for me, I've tried several tools and one conversion calculator showed that it would only be a few hundred dollars difference for me to do conversions, but another tool indicated I could spend a few thousand more dollars a year if I do conversions (but also pay a lot more in taxes, so confusing).

Currently I am spending a lot more than is sustainable because I am on a grand retirement travel around the US, and I am using money from selling my house so it doesn't increase my taxable income. But, I have no idea what effect the money from selling the house will have on my income, I put some of it into my favorite index fund but then realized that fund pays a good dividend and since it is in a regular (not tax advantaged) investment account those dividends are going to be unavoidable income. I need to figure out what I can invest in that doesn't pay much dividend so that I'll only have to pay capital gains tax instead. So much to learn!
 
One of the big reasons we shifted our portfolio upon retirement, from a DIY investing (which I did very well at), over to an independent CFP firm, was that I did not want to hassle about taxes on distributions. Half our portfolio is taxable and half is an IRA - sadly Roths were not available to my spouse until a year before he retired, so we ran the #s but it wasn't worth doing the conversions.

Our taxable portfolio is managed with tax planning in mind, so the distributions we take are 80% tax-free. When spouse gets to the RMD age, we will probably take a tax hit, but that's the price of doing well, as the saying goes. We'll stop most or all of the distributions from the taxable account at that point, since this and my SocSec check are our "spending $$$" (pensions cover our overhead).

If you are handling your own sell orders to the brokerage/financial institution, be sure to specify FIFO; LIFO is the default but often the biggest tax hit. Long term capital gains are taxed much lower than short-term cap gains.

Our CFP firm advised that they are currently using the market downturn to do "wash sales" to harvest tax losses for its clients' future tax returns.

As Bowmore pointed out, doing charitable donations can help. We use a DAF (Donor Advised Fund) for our donations; just FYI a QCD cannot go to a DAF. Our firm sells the appropriate stocks and then transfers the cash to Schwab's DAF for maximum tax efficiency.
 
C50 said:
I didn't fully realize the tax implications 401(k) money or capital gains would have on my Social security benefits, I knew there would be tax but didn't realize the full implications.

I am right at the edge that with no other income my SS benefits aren't taxed, but it doesn't take much to be at 85% of my benefits being taxed. And there's also the concern of pulling too much money in one year and having your Medicare cost increased. I now realize if I want to spend a chunk of money it's not as simple as pulling investment money, there's lots of financial strings attached. It feels like I get punished for all those years of being financially prudent.

So is it just me? Have others found they had to scale back retirement plans even though they have the money?
Click to expand...
I would suggest you talk to your financial advisor. I would think that if you could not be concerned with not paying taxes but to pay little taxes, you would be better off. Another words stay below the min tax bracket but convert 401K funds to a Roth, where later you would not pay taxes on the withdrawals. When you get to RMD time you will have reduced some of those taxable dollars. You did not save your money to live on beans while having money in the bank. A good advisor should help you with this. If you have been very prudent you should be able to enjoy some of the interest without disturbing the principal and adding it to your SS while also affording the small amount of taxes.
 
HoneyNut said:
I have been learning about this too since I retired this year. I wish I'd learned about money and retirement a long time ago, I didn't understand about Roth IRAs, and also the past few years when I'd learned about traditional IRAs I needed the tax deduction of the contribution in order to have money to contribute. But there were a couple years several years ago when I was making a better income and wanted to contribute more but didn't know the value of the 401k contributions (I'd only ever heard about make enough contribution to get company match, but the company had no match and I didn't understand I'd have less taxes just from contributing anyway, I was so sadly ignorant!).

Apparently the correct way to have prepared for retirement taxation is to have saved part of your retirement money in a traditional IRA and part of your money in Roth IRA, then the RMDs from the traditional would be less and the Roth IRA money could be used to avoid tipping over the income line that causes higher IRMAA thingy.

If you have a lot of money, and you are young enough to have more than 10 years ahead of you, then a lot of people recommend doing conversions from traditional IRA to roth IRA up to a particular income bracket. It is all too complicated for me, I've tried several tools and one conversion calculator showed that it would only be a few hundred dollars difference for me to do conversions, but another tool indicated I could spend a few thousand more dollars a year if I do conversions (but also pay a lot more in taxes, so confusing).

Currently I am spending a lot more than is sustainable because I am on a grand retirement travel around the US, and I am using money from selling my house so it doesn't increase my taxable income. But, I have no idea what effect the money from selling the house will have on my income, I put some of it into my favorite index fund but then realized that fund pays a good dividend and since it is in a regular (not tax advantaged) investment account those dividends are going to be unavoidable income. I need to figure out what I can invest in that doesn't pay much dividend so that I'll only have to pay capital gains tax instead. So much to learn!
Click to expand...
I'm not sure but selling the house and spending the money on a trip may be considered income, as it wasn't rolled into another house. You may want to stop the trip and talk with a accountant in your travels because this may be added to your other income comes tax time. Even if you are retired you can roll 401k money into a Roth conversion paying lower taxes on it then when you were working. Just convert enough that keeps you in the lower tax brackets.
 
Creek Pirate said:
I'm not sure but selling the house and spending the money on a trip may be considered income, as it wasn't rolled into another house. You may want to stop the trip and talk with a accountant in your travels because this may be added to your other income comes tax time. Even if you are retired you can roll 401k money into a Roth conversion paying lower taxes on it then when you were working. Just convert enough that keeps you in the lower tax brackets.
Click to expand...
The conversion will reduce your taxable RMD funds while allowing you not to have to tap the converted money.
 
Creek Pirate said:
I'm not sure but selling the house and spending the money on a trip may be considered income, as it wasn't rolled into another house.
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The house was my residence for the previous 12 years, and the gain from the sale did not exceed the amount that the IRS allows as exempt from capital gains taxes, so it should be okay tax-wise. I'm more concerned that having put the money into my investment account is somehow going to surprise me with interest, dividends, or capital gains that cause me to owe taxes and penalties for not having paid estimated tax during this year. In the past I invested in mutual funds, but now I'm learning that ETFs are better (more 'tax efficient') in a taxable account.

Here is what I found on the IRS tax website regarding money from selling a house:
If you have a capital gain from the sale of your main home, you may qualify to exclude up to $250,000 of that gain from your income, or up to $500,000 of that gain if you file a joint return with your spouse. Publication 523, Selling Your Home provides rules and worksheets. Topic No. 409 covers general capital gain and loss information. ​
In general, to qualify for the Section 121 exclusion, you must meet both the ownership test and the use test. You're eligible for the exclusion if you have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its date of sale.​
 
Chet said:
Can you withdraw just enough to keep you under the taxable level of your withdrawals?
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That is my plan for future years, but this year is awkward because I retired in March (i.e., already had "income" this year) so I am having to live off the taxable account entirely to avoid being pushed into a higher tax rate and pay unnecessary taxes.

But I struggle trying to understand what taxable distributions beyond-my-control happen in my taxable account. As far as I have figured out so far, Fidelity lumps together on their analysis webpage all of my qualified dividends, unqualified dividends, foreign stuff, capital gain distributions, and interest. So I can see how much money is produced for current and past quarters/years, but I am not sure about how much of it will count toward "income" and it seems like (I might misunderstand it though) capital gains are kind of random. Also I'm worried about unpredictable distributions that might suddenly happen in December.

This is the first year of my life I have to think about estimated tax payments, and from what I've read it sounds like we have to make the payments quarterly, but if I don't know until December what distributions will happen, I don't know how to estimate the taxes. I could make some tax payments 'just in case' but with the current inflation it seems like a waste to have money sit with Uncle Sam until next April.
 
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Creek Pirate said:
I'm not sure but selling the house and spending the money on a trip may be considered income, as it wasn't rolled into another house. You may want to stop the trip and talk with a accountant in your travels because this may be added to your other income comes tax time. Even if you are retired you can roll 401k money into a Roth conversion paying lower taxes on it then when you were working. Just convert enough that keeps you in the lower tax brackets.
Click to expand...
The conversion will reduce your taxable RMD funds while allowing you not to have to tap the the converted funds that will be tax free funds except any capital gains created. During the RMD time it is better to use this 401K pretax money before touching after tax money. In a conversion you are trying to move money while staying under the minimum tax bracket and lower your 401k pretax money for later on. Your doing this in your 60's mostly.
 
Creek Pirate said:
In a conversion you are trying to move money while staying under the minimum tax bracket and lower your 401k pretax money for later on.
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Yes, I guess I will run the numbers again next year to see if a conversion will be beneficial. I am apparently right at the borderline where it might not make any difference (I might not have enough 401k money to have an eventual RMD amount that would push my tax bracket up too much, though of course a lot depends on how the stock market does - right now my 401k is looking sad, ha ha).

But this year I did recharacterize last year's IRA contribution from traditional to Roth, and also I made my this year's IRA contribution directly to the Roth, so I've avoided needing to convert those amounts, yay! (would feel better tho if my choice of investment hadn't promptly dropped 16% of its value, sighhhhhh).
 
Honeynut, were I in your position I would find a knowledgeable tax advisor and detail your situation to him/her to ask for recommendations. And that does NOT mean an HR Block or "quickie refund" type of tax preparer. Nothing against them, but I'd personally would be more comfortable with someone who is looking at my total and future tax liabilities.

Hope you find your answers soon and that they are helpful! Good luck.
 
There are several points to consider when evaluating whether to perform Roth Conversions or follow the Uncle Sam Plan (paying RMDs for the rest of your life):

Future Tax Rates: Do you believe taxes rates and brackets will be higher in the future? We know, short of congressional action, that the Tax Cuts and Job Act will automatically sunset December 31, 2025 and tax rates and brackets will revert to their previous, higher rates. So yes, taxes will automatically go up in 2026. Many believe with the current governmental spending that rates must increase in the future to cover the national debt. We may be experiencing the lowest rates of our lifetime. Remember also for couples there is a tax break for married filing jointly, when one has passed away, the remaining one is now filing single and at a higher rate.

Taxable Social Security: Did you know that up to 85% of your social security benefits can be taxable based on income from other sources such as pensions, IRAs, annuities, brokerage accounts? Withdrawals from Roth IRAs are not taxable and do not contribute to this adder for Social Security taxation. For couples filing jointly if your income is from $32,000 to $44,000 up to 50% of your SS benefits may be taxable, if more than $44,000 up to 85% can be taxable. For single filers, $25,000 to $34,000 up to 50% of your SS benefits may be taxable, if more than $34,000 up to 85% can be taxable... 2023 rates. Most tax payers do pay Social Security taxes.

IRMAA Surcharge on Medicare: This is an adder charge to the monthly Medicare premium based on the annual income of the recipient. Income-Related Monthly Adjustment Amount (IRMAA) can be up to $560.50 for Part B and $76.40 for Part D per month if income is above $194,000 per year (Married Filing Jointly) or $97,000 per year (Filing Single)... 2023 rates.

On the surface these income rates, especially the ones for IRMAA seem very high, but a quick review of what your projected RMDs will be in your late 70's and beyond show that they quickly climb and remain high and these surcharges remain for the rest of your life. The true driving factor to converting monies to Roth IRAs is to reduce or eliminate taxes (of multiple types) in the future. I've heard rough numbers of a portfolio at or greater than $1M should evaluate Roth conversions.

I'm not an accountant or tax professional but did stay at a Holiday Inn Express... and have done a tremendous amount of reading and modeling to confirm above for myself.
 
C50 said:
I didn't fully realize the tax implications 401(k) money or capital gains would have on my Social security benefits, I knew there would be tax but didn't realize the full implications.

I am right at the edge that with no other income my SS benefits aren't taxed, but it doesn't take much to be at 85% of my benefits being taxed. And there's also the concern of pulling too much money in one year and having your Medicare cost increased. I now realize if I want to spend a chunk of money it's not as simple as pulling investment money, there's lots of financial strings attached. It feels like I get punished for all those years of being financially prudent.

So is it just me? Have others found they had to scale back retirement plans even though they have the money?
Click to expand...
My wife and I have been fully retired for 13 years. I just turned 81. By far our biggest annual expense is taxes, Federal and State (Calif). And I am an Enrolled Agent, supposedly a tax expert.
 
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