CARES act and withdrawing from 401k to move to taxable?

[hightower]

This is just a thought I had, so don't shoot me for thinking out loud.

Seeing that we can avoid the 10% penalty thanks to the CARES act (and since my wife had a qualifying event...she had to take a voluntary separation package due to no child care at home during covid) would it make any sense for us to withdraw 100k from my wife's 401k (which has terrible, expensive investment choices) and move it to our taxable account? The tax burden on that 100k could be spread out over 3 years and since she will not be working or earning money next year, our taxes would be the same as if she had been working. So, yes, we'll be paying taxes on that 100k, but it's equivalent to her working for 2 years and just putting it into a taxable account instead of a 401k.

My thinking is that having a beefed up taxable will give us more flexibility to potentially pay off our mortgage earlier if we needed to.

Honestly I'm barely luke-warm on the idea, but it's tempting to me because our taxable account is currently still one of our smallest accounts. The vast majority of our other funds are locked up in tax-advantaged accounts that we can't touch until retirement age. The other piece of the puzzle is that there's a good chance my high paying career will be going away a year from now (though nothing is certain right now, I'm nearly 100% sure I have fewer than 3-4 years tops at my current job and I don't want to work as a doctor anymore after that), and we will likely be in a much lower tax bracket for the rest of our working careers. So, having a much larger taxable account gives us the option to use that money if we need it in the future, whereas leaving it in the 401k makes it untouchable until 59 1/2 years old. We want to stay in our current house permanently so having a taxable account with enough cash to pay off the mortgage at anytime, makes me feel all warm and fuzzy inside.

[Lithium]

Just how bad are these investment options? What's the lowest ER?

There are a lot of ways to get money out of retirement accounts prior to 59.5, including 72(t) (SEPP). You may pay less in taxes that way too.

I'm not crazy about moving money to taxable accounts because of the taxes you pay on dividends every year.

[JBME]

how old are you guys? the younger you are the less I like the idea. This idea may be tempting but it's complex and will require you to be on your toes to do things correctly and efficiently in the next few years. a lot of work

[spiritrider]

If there really are such horrible investment choices/costs and she is eligible for a CRD. Why not consider eventually rolling it over to an IRA or even better back into a future employer's better retirement plan..

She has three years to do the rollover to prevent a pre-tax IRA balance from interfering with the Backdoor Roth. 1/3 of the CRD will be taxable this year and next, but is refundable with amended tax return(s) after a rollover back to an eligible retirement account.

[EntrepreneurMD]

Someone please explain to me this question that has been nagging me for a long time.

Sure IRA's, 401(k)'s allow you to grow you untaxed contributions tax deferred for a long time then pay taxes at your individual (unpredictable future rate and often high tax bracket for physicians anyway) tax rate when the time comes to withdraw.

Why is that so much better than a taxable account where yes you are paying taxes but at the lower long term capital gains rate and in the end, the fact that you can have these resources (with taxes already paid) in retirement you can have a much lower tax rate potentially then too? Dividends (for short term capital gains) are generally a small portion of the package unless you are specifically focused on optimizing dividends.

I know the answer is often you should have both. But what makes #1 better than #2? Does the math say you come out materially ahead in the end? Is it that you're essentially forced to keep it untapped in until a certain age? Is it (for physicians) due to the med-mal protections? or does it indeed work out better from a purely mathematical perspective?

And if there's not much financial benefit to 2 over 1, what makes Hightower's idea so preposterous?

That being said, I wouldn't do it Hightower, but that's more out of ignorance on the topic than anything else in my case.

[OncDoc123]

Someone please explain to me this question that has been nagging me for a long time.

Sure IRA's, 401(k)'s allow you to grow you untaxed contributions tax deferred for a long time then pay taxes at your individual (unpredictable future rate and often high tax bracket for physicians anyway) tax rate when the time comes to withdraw.

Why is that so much better than a taxable account where yes you are paying taxes but at the lower long term capital gains rate and in the end, the fact that you can have these resources (with taxes already paid) in retirement you can have a much lower tax rate potentially then too? Dividends (for short term capital gains) are generally a small portion of the package unless you are specifically focused on optimizing dividends.

I know the answer is often you should have both. But what makes #1 better than #2? Does the math say you come out materially ahead in the end? Is it that you're essentially forced to keep it untapped in until a certain age? Is it (for physicians) due to the med-mal protections? or does it indeed work out better from a purely mathematical perspective?

And if there's not much financial benefit to 2 over 1, what makes Hightower's idea so preposterous?

That being said, I wouldn't do it Hightower, but that's more out of ignorance on the topic than anything else in my case.

It's a math problem, and as a doc in a high tax bracket, you will almost always come out ahead by taking advantage of tax deferred accounts.

1. $1 in Roth is always better than a taxable account, as it grows without tax drag (~.3-.5%/year for an index investor) and it does not have any capital gains at withdrawal

2. IF your marginal tax rate at time of contribution is the same as your marginal tax rate at the time of withdrawal, a traditional IRA (or 401k) contribution is mathematically equal to a Roth contribution. E.g. Assume you're in the 35% tax bracket, you want to contribute $100, it will grow 10x by the time you retire, & your tax rate in the withdrawal in retirement will be 35%... If you make a Roth contribution you place $65 in the account (you had to pay taxes today), it grows to $650 in retirement and you can withdrawal/spend $650. If you placed it in a traditional, you would invest $100 (pre-tax), it grows to $1000, and you can spend $650 after you pay taxes.... Mathematically equivalent.

4. If your tax rate goes down in retirement, a traditional is even better than a Roth. In the example above, if you're at 25% tax rate in retirement, your $1000 traditional IRA would produce $750 to spend after taxes.

5. Tax deferred accounts let you spread your income out so that you can fill up the low tax bracket "buckets" in low earning years; this is super helpful for people with short, high earning careers (super super beneficial for the FIRE crowd), and allows lots of those traditional IRA dollars to get pulled out at lower tax rates (or converted to Roth at lower tax rates). For every dollar you get out of a traditional IRA at a lower tax rate than you saved on it going in, you made a big tax win.

6. Even if your tax rate goes up slightly in retirement (to a point), a traditional IRA may still be better than taxable... Remember that if tax rates are equivalent at contributions and withdrawal, a tIRA is mathematically equivalent to a Roth (which benefits from tax free growth and no capital gains tax on withdrawal)... It would take a few percentage points of negative tax arbitrage to counteract those benefits.

[Tim]

No where in the math is liquidity premium or supplemental value added adjusted.

Any retirement account is excluded from most financial strength evaluations, they are invisible.
Three year rates are different than 5 year rates.
Just saying, the tax only calculation is the tail, consider the dog as well. Investment limitations?

[spiritrider]

Some thoughts on additional reasons why most physicians should prioritize tax-advantaged accounts.

• With their high income and mid to high five figures annual retirement savings. In most cases a majority of assets will taxable anyway by retirement.
• The vast majority of taxable should be invested in tax-efficient equities. To the degree possible, the vast majority of tax inefficient equities and fixed income should be in tax-advantaged accounts.
• The reasons for this are not just the ordinary income tax vs. capital gains differential. Which can change with the political winds. Do you really want to have highly appreciated stock when that differential is reduced or eliminated.
• You need to factor in the yearly tax drag. With equities, dividends alone can represent the majority of returns. Not to mention capital gains distributions of mutual fund. Finally, tax drag of any fixed income can catastrophically reduce long-term returns.
• No to mention all this additional yearly income can push you into higher marginal tax brackets, phase-outs or even cliffs. You lose a significant capability for tax planning and management.
• Tax-advantaged accounts provide a tax-free ability to rebalance and adjust your asset allocation approaching and into retirement. Taxable investments will require the sale of highly appreciated securities to accomplish this. Producing even more tax drag.

With that said, someone can accumulate too much tax-deferred if they have access to multiple accounts and/or the ability to reach the annual addition limit. There can be such a thing as the RMD tax bomb.

Personally, I believe it is best in retirement to have 20% - 60% of tax-deferred, taxable and tax-free. This may mean prioritizing tax-deferred early*, using additional Roth IRA and HSA space, raising taxable investments as your income increases and Roth conversions in early retirement and before SS.

*Those with multiple accounts and or full annual addition limits might want to consider making 20-25% of their tax-advantaged contributions (including Roth IRA) as Roth. Especially, a self-employed individual eligible for the QBI deduction.

[hightower]

Just how bad are these investment options? What's the lowest ER?

There are a lot of ways to get money out of retirement accounts prior to 59.5, including 72(t) (SEPP). You may pay less in taxes that way too.

I'm not crazy about moving money to taxable accounts because of the taxes you pay on dividends every year.

The best ER is like 0.6% or something like that. I will have to read up on the 72(t) you mention

[hightower]

how old are you guys? the younger you are the less I like the idea. This idea may be tempting but it's complex and will require you to be on your toes to do things correctly and efficiently in the next few years. a lot of work

We’re both late 30’s

[JBME]

personally I would not do this (probably) because it's a lot of stuff to keep track of. But yes an ER of .6 being the lowest isn't great. Spiritrider had great suggestions. I'm in a similar boat as you-so much tax-advantaged space I won't have a big enough taxable at time of retirement but also being in my late 30s, I'm not going to do anything about it yet

[Lithium]

I think spiritrider's point about tax planning is especially good. If you want to qualify for ACA subsidies (assuming those remain available) after punching out of medicine, it is much easier and potentially more generous if you can minimize dividends from a taxable account every year.

[Kennyt7]

Most doctors greatest wealth accumulator is their pension plan as its forced tax deferred compounded savings. It does not take much yearly top create millions at Full Ret Age. In my case in Florida I am paying an effective tax rate of 17% on 300k income; lots less when I was a dentist
I would not cash in a 401k