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Author: edcosoft Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121061  
Subject: Re: 401K Income averaging Date: 3/30/1999 2:40 PM
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buznitz wrote: I am eligible for 5 and 10 year income averaging of total withdrawel from
a 401K (over 300K). After looking at the tax schedules (as high as 50%) I
fail to see the advantage of income averaging versus partial withdrawels
starting at age 70-1/2 in six years. I don't need the money now and intend to
leave most of it to children. Am I missing some advantage?


You didn't do the arithmatic right, or read the tables and instructions wrong as it averages just over 22% either way.
The following is calculated ONLY on the taxable portion of the distribution if you put in any after-tax contributions. Presume Lump Sum is $307,000/5 = 61,400 From Tax Table pg 4 of Instructions for Form 4972 tax is $13,896.50 X 5 = $69,482.5. This is 69,482.5/307,000 = 22.63273% Average Tax Rate. That's almost as low as the current L.T. Cap Gain rate, and probably lower than your personal 28% or 31% rate, or your kid's bracket of 28% or 31%, or even worse if they have to take it out all at once. Of course if you're all in the 15% bracket, take it out monthly.
Using 10 year averaging take 30,700 from 10 year tax tables = $6,170 + .34 X 2,100 = 6,871 X 10 = $68,710 tax on $307,000 = 22.3811%. This is a little better than 5 year averaging.
If ANY of your participation in THIS company's plan(s) predates 1974 use pre 1974 capital gains @ 20% of total funds for % of time pre 1974 versus total time in plans. This includes predecessor plans and predecessor companies if there were mergers or buyouts and rollovers of prior pension or profit sharing plans into the 401K.
Also, if you have 2 or more pensions from absolutely different sources, withdraw them both in the same year and file multiple 4972s because even though you're one person you are MULTIPLE PLAN PARTICIPANTS. If this applies, e-mail me and I'll tell you how to get around TurboTax's limit of only allowing one 4972.
Note the rules: Can't do it from an IRA, if done previously, etc. Read Form 4972 and Instruction.
Further advantages to taking a lump sum is the value of the tax you pay (or your kids would pay) is out of your Estate and not double taxed. You can put the money in
a Living Trust. You can diversify your investments. You can spend some of it. You can gift some of it to your kids before you die so they can enjoy it now and get it out of your Estate.
The DISADVANTAGE is that in the 401K or a rollover IRA it would compound tax free. So invest it in a tax managed growth and income fund, or an index fund or a growth stock that doesn't distribute dividends. That way if you have to spend some you'll take it and pay only a Long Term Cap Gains rate on the percentage of the withdrawal attributable to the growth of the funds. You could withdraw all of it after it doubled and it would still be advantageous if you and the kids are in the 28% bracket. However, your heirs get a free step-up in basis upon your death which effectively makes it a tax free growth investment.
The sooner you do it the better as your withdrawal is into the 31% tax BRACKET for 5 year averaging and 34% for 10 year. In other words, further growth of the 401K will be taxed higher than the 22% current average.
By the time you're 70 the withdrawal tax bracket might be 36%. If the funds double to $600,000 and you look at a lump sum withdrawal, the average tax rate becomes 27.11%. Ed
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