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Author: bobpoole Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75384  
Subject: Early Retirement Package Date: 8/23/1999 9:30 PM
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I am about to take an early retirement (at age 55+) from my employer, but plan on continuing my career and building a second retirement in about five to seven years. My employer provided me with a savings and investment plan which consists of before-tax (401(k)) contributions, matching funds from the employer (mostly used to purchase company stock) and after-tax savings.

I am at the point in time where I wish to take control and invest all of these Foolishly by investing from a self-directed IRA (tax-deferred funds) and a regular investment account (after-tax). I plan on taking distributions from all accounts after my eventual second retirement.

I am a little confused as to the lump-sum tax ramifications on this plan mix. Some is in a well-performing indexed fund, some in company-contributed stock (as Tom and Dave say, "Free Money") and some in "post-1986 Basis" funds. How does one direct the proceeds from such a managerie keeping the best tax strategies in mind?

I'd appreciate any information . . .

bp
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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13396 of 75384
Subject: Re: Early Retirement Package Date: 8/24/1999 10:10 AM
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Greetings, BP, and welcome. You wrote:

<<I am about to take an early retirement (at age 55+) from my employer, but plan on continuing my career and building a second retirement in about five to seven years. My employer provided me with a savings and investment plan which consists of before-tax (401(k)) contributions, matching funds from the employer (mostly used to purchase company stock) and after-tax savings.

I am at the point in time where I wish to take control and invest all of these Foolishly by investing from a self-directed IRA (tax-deferred funds) and a regular investment account (after-tax). I plan on taking distributions from all accounts after my eventual second retirement.

I am a little confused as to the lump-sum tax ramifications on this plan mix. Some is in a well-performing indexed fund, some in company-contributed stock (as Tom and Dave say, "Free Money") and some in "post-1986 Basis" funds. How does one direct the proceeds from such a managerie keeping the best tax strategies in mind?>>


All the pre-tax money in your plans will be transferrable to an IRA. Whatever it's invested in now will be cashed out. The cash will be sent to whatever IRA you choose and may be invested within that IRA as you see fit. You will almost certainly be given the option to take the company stock in whole shares. Those may be transferred to a brokerage IRA to continue the tax deferral or you may have them issued to you. If issued to you, you will have to pay income tax on the cost of those shares (but not on any gain since purchase) at the time they were bought. The plan will tell you what the cost basis is. Afterwards, you may sell those stocks and only pay income taxes at the capital gains rate. If the shares go into an IRA, then when you sell them to take a distribution from the IRA everything gets taxed at ordinary income tax rates. Any after-tax money in your plans may not be transferred to an IRA. You will receive any after-tax money from the plan(s) free of tax and can do with it what you wish.

Regards..Pixy

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Author: KGWood One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13420 of 75384
Subject: Re: Early Retirement Package Date: 8/24/1999 3:28 PM
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Pixy, you say "Any after-tax money in your plans may not be transferred to an IRA. You will receive any after-tax money from the plan(s) free of tax and can do with it what you wish."

My question: what about the EARNINGS on the after-tax contributions? Is that included with the after-tax monies to be done with as one wishes, or is that included with the before-tax monies that are rolled over into an IRA?

Thanks

Ken

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Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13421 of 75384
Subject: Re: Early Retirement Package Date: 8/24/1999 3:34 PM
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The earnings on the after tax contributions can go into the the IRA, and in fact you will pay penalty if you withdraw them. So everything that moves from 401K to IRA Rollover is pretax and anything after tax must come out of the account. However, there is no penalty or taxes due because you have already paid tax on the after tax money. Its just that future income on the aftertax money is no longer in the tax protected account, so the income becomes taxable. This tax burden limits how fast it can grow.

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13422 of 75384
Subject: Re: Early Retirement Package Date: 8/24/1999 3:43 PM
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Ken writes:

<<Pixy, you say "Any after-tax money in your plans may not be transferred to an IRA. You will receive any after-tax money from the plan(s) free of tax and can do with it what you wish."

My question: what about the EARNINGS on the after-tax contributions? Is that included with the after-tax monies to be done with as one wishes, or is that included with the before-tax monies that are rolled over into an IRA?>>


As Pauleckler points out, earnings may and should be transferred to the IRA. You have never paid income tax on them, so they are eligible for the transfer. The after-tax contributions are the only money that cannot be put into the IRA. And, because the tax on that sum has already been paid, you may do with it what you wish. It just cannot continue to grow in a qualified retirement plan on a tax deferred basis.

Regards..Pixy

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Author: intercst Big funky green star, 20000 posts Top Favorite Fools Top Recommended Fools Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13423 of 75384
Subject: Re: Early Retirement Package Date: 8/24/1999 4:49 PM
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TMFPixy wrote,

As Pauleckler points out, earnings may and should be transferred to the IRA. You have never paid income tax on them, so they are eligible for the transfer. The after-tax contributions are the only money that cannot be put into the IRA. And, because the tax on that sum has already been paid, you may do with it what you wish. It just cannot continue to grow in a qualified retirement plan on a tax deferred basis.

Pixy's and Paul's comments are quite true, however, I'm not sure that the fact your money "cannot continue to grow in a qualified retirement plan on a tax deferred basis" is necessarily a disadvantage. (And Pixy may not be implying it's a disadvantage.)

If you put your taxable money in a Tax-Managed Index Fund or a LTB&H stock portfolio, most of your gains will be taxed at the capital gains rate (max=20%). All of you earnings in an IRA are taxed as ordinary income (max=39.6%). It's a huge difference if you're in one of the higher tax brackets.

intercst

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Author: pauleckler Big funky green star, 20000 posts Top Favorite Fools Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13431 of 75384
Subject: Re: Early Retirement Package Date: 8/25/1999 9:06 AM
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Intercst makes a good point, but loss of tax protection on the aftertax portion of your investment can be one reason to keep a 401K rather than transfer to an IRA Rollover, if you have that option and other aspects of the 401K are OK.

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Author: buznitz One star, 50 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13435 of 75384
Subject: Re: Early Retirement Package Date: 8/25/1999 10:59 AM
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Hey Pixy:

We all need to read IRS Publication 575 page 20,21,22.
The rules are convoluted. Transfer to an IRA is NOT a lump sum distribution. Unless one withdraws entire 401K one cannot defer the LTCG of the stock portions NUA. If stock is transferred to an IRA you lose the LTCG advantage even though you defer taxes until you sell stock(but it becomes ordinary income). I thought about taking a lump sum from ALL of my employer's 401K account and doing long term averaging without including the stock portion NUA(only paying taxes on the cost basis of the stock and deferring LTCG until the stock is sold). The tax bite using 5 or 10 year averaging was too large for me to swallow. Either way the tax man cometh

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 13438 of 75384
Subject: Re: Early Retirement Package Date: 8/25/1999 11:43 AM
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Buznitz writes:

<<We all need to read IRS Publication 575 page 20,21,22.
The rules are convoluted. Transfer to an IRA is NOT a lump sum distribution. Unless one withdraws entire 401K one cannot defer the LTCG of the stock portions NUA. If stock is transferred to an IRA you lose the LTCG advantage even though you defer taxes until you sell stock(but it becomes ordinary income). I thought about taking a lump sum from ALL of my employer's 401K account and doing long term averaging without including the stock portion NUA(only paying taxes on the cost basis of the stock and deferring LTCG until the stock is sold). The tax bite using 5 or 10 year averaging was too large for me to swallow. Either way the tax man cometh.


Yes, that's absolutely true. You want to pay taxes up front in one year on the entire lump sum. In that case, you can't use the capital gains advantage of taking company shares. Paying the income taxes immediately on retirement plan lump sums rarely makes sense even when one can use long-term income averaging. There are rare exceptions to this, but not many. Generally, normally, usually, invariably, it's best to transfer most of the proceeds to an IRA and only keep (and pay taxes on) part of the distribution. Do so with company shares, and you get the added benefit of being able to use long-term capital gains rates on the NUA even if sold immediately after receiving them.

Regards..Pixy

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