Message Font: Serif | Sans-Serif
 
UnThreaded | Threaded | Whole Thread (14) | Ignore Thread Prev Thread | Next Thread
Author: 2gifts Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121144  
Subject: question on potential 401k rollover/distribution Date: 12/1/2013 10:11 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
I think this is the right board for this question.

My 22-year-old DS is most likely changing jobs soon, and so will have a very small amount of money in his 401k since he just became eligible and started contributing in August. Since the amount in the 401k is so small, I expect the plan will automatically send him a check for that money. He makes very little, and so is in the lowest tax bracket.

What should he do with that 401k money? If they send it to him as a distribution, will he only pay taxes on it, or is there also a penalty? If a penalty, then could he just roll that over to an IRA to avoid the penalty? If no penalty, I would think that paying the taxes on it now and putting it in his Roth IRA would be a better choice for him.

What should I advise him to do, or what else should be considered as he makes this decision?
Print the post Back To Top
Author: TMFPMarti Big funky green star, 20000 posts Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 119606 of 121144
Subject: Re: question on potential 401k rollover/distribu Date: 12/1/2013 11:15 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 2
My 22-year-old DS is most likely changing jobs soon, and so will have a very small amount of money in his 401k since he just became eligible and started contributing in August. Since the amount in the 401k is so small, I expect the plan will automatically send him a check for that money.

If they follow the rules they will advise him of his options and ask him what he chooses. The required options vary depending on how much his has in the account, but one option must always be to do a tax-free rollover to a traditional IRA.

He makes very little, and so is in the lowest tax bracket.

What should he do with that 401k money? If they send it to him as a distribution, will he only pay taxes on it, or is there also a penalty?


First they will withhold 20% of the gross distribution for Federal income tax. He will owe income tax on the gross plus 10% of the gross as a premature distribution penalty if he's under 59 1/2.

If a penalty, then could he just roll that over to an IRA to avoid the penalty?

Yes. Doing a direct transfer would also avoid the withholding.

If no penalty, I would think that paying the taxes on it now and putting it in his Roth IRA would be a better choice for him.

That sounds best to me too, given his low current tax rate.

See Publications 575 and 590 for a detailed discussion.

Phil
Rule Your Retirement Home Fool

Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post Back To Top
Author: PSUEngineer 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: 119607 of 121144
Subject: Re: question on potential 401k rollover/distribu Date: 12/1/2013 11:24 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 3
If a penalty, then could he just roll that over to an IRA to avoid the penalty?
------------------
Yes. Doing a direct transfer would also avoid the withholding.
-------------------
If no penalty, I would think that paying the taxes on it now and putting it in his Roth IRA would be a better choice for him.
--------------------
That sounds best to me too, given his low current tax rate.


Maybe something isn't coming through correctly on the translation. Since there is a penalty, how would it sound best to you?

It seems that the best route would be to do a rollover to a traditional IRA, then convert the traditional IRA to a Roth IRA due to his current low tax rate. That may be what you are saying but it was confusing in how it was worded.

PSU

Print the post Back To Top
Author: TMFPMarti Big funky green star, 20000 posts Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 119608 of 121144
Subject: Re: question on potential 401k rollover/distribu Date: 12/1/2013 11:35 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Maybe something isn't coming through correctly on the translation. Since there is a penalty, how would it sound best to you?

Not sure what made you think I said there's a penalty on conversion to Roth, but there isn't. It used to be necessary to go 401(k)->traditional IRA->Roth IRA, but for several years you've been able to skip the middle step.

Phil
Rule Your Retirement Home Fool

Print the post Back To Top
Author: 2gifts Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 119609 of 121144
Subject: Re: question on potential 401k rollover/distribu Date: 12/1/2013 11:36 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 1
Thanks to Phil and PSU on the quick response.

It seems that the best route would be to do a rollover to a traditional IRA, then convert the traditional IRA to a Roth IRA due to his current low tax rate. That may be what you are saying but it was confusing in how it was worded.


I actually figured this is what Phil is saying. It sounds like he should set up the Traditional IRA, do the rollover, and then do the conversion to the Roth IRA.

You folks are the best. Thanks for the help.

Print the post Back To Top
Author: 2gifts Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 119610 of 121144
Subject: Re: question on potential 401k rollover/distribu Date: 12/1/2013 11:38 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
It used to be necessary to go 401(k)->traditional IRA->Roth IRA, but for several years you've been able to skip the middle step.

Even better. I didn't know he could skip the middle step, and he already has a Roth IRA, so this is the route I will suggest.

Now, I have my fingers crossed that he gets the other job he is looking at, but at least he is looking.

Print the post Back To Top
Author: PSUEngineer 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: 119611 of 121144
Subject: Re: question on potential 401k rollover/distribu Date: 12/1/2013 8:39 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Not sure what made you think I said there's a penalty on conversion to Roth

I didn't think you said that. 2gifts was talking about early withdrawal penalty. Here is the whole sentence instead of your parsing:

What should he do with that 401k money? If they send it to him as a distribution, will he only pay taxes on it, or is there also a penalty? If a penalty, then could he just roll that over to an IRA to avoid the penalty? If no penalty, I would think that paying the taxes on it now and putting it in his Roth IRA would be a better choice for him.

From what I read in that sentence, the word penalty in the last sentence which starts with "If no penalty" is still referring to the early withdrawal penalty. So again that's why it seemed strange your response had "that sounds best" after that sentence.

PSU

Print the post Back To Top
Author: RHinCT Big red star, 1000 posts Ticker Guide SC1 Red Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 119612 of 121144
Subject: Re: question on potential 401k rollover/distribu Date: 12/1/2013 10:44 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Keep in mind that the rollover to a Roth still has some taxable amount, and that can NOT come from those funds. (At least if I've learned things correctly from reading this board for a few years.)

Print the post Back To Top
Author: TMFPMarti Big funky green star, 20000 posts Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 119613 of 121144
Subject: Re: question on potential 401k rollover/distribu Date: 12/1/2013 11:10 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 8
Keep in mind that the rollover to a Roth still has some taxable amount, and that can NOT come from those funds.

Since we're talking about money coming from a 401(k) it's likely that the entire amount will be taxable upon conversion to Roth. If you paid the tax from the distribution that would mean the 10% penalty on the amount used to pay the tax since that amount wasn't converted or rolled over. This is why it's also important that whether you're going to a traditional or Roth IRA you do a direct transfer from the plan to the IRA custodian. Otherwise the plan must withhold 20% of the gross for Federal taxes. If you don't make up that 20% from other funds it's a distribution which may be subject to the 10% penalty.

Phil
Rule Your Retirement Home Fool

Print the post Back To Top
Author: reallyalldone Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 119614 of 121144
Subject: Re: question on potential 401k rollover/distribu Date: 12/2/2013 10:26 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
He makes very little, and so is in the lowest tax bracket.

It just struck me that this is the graduation year for your kids which can be a bit difficult for tax purposes. For one of mine, it was easy because most of her college expenses for the beginning of that year were covered by the USAF so it was clear she wasn't a dependent. For the other two, it wasn't as clear and I would have to go back to the tax returns to see what we did.

Would it make a difference if he gets the distribution in 2013 or 2014 ? Did you provide more than half his support for 2013 ? (These are questions to consider - not nece3ssarily to answer)

Print the post Back To Top
Author: 2gifts Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 119615 of 121144
Subject: Re: question on potential 401k rollover/distribu Date: 12/2/2013 10:35 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
Would it make a difference if he gets the distribution in 2013 or 2014 ?

I don't think this will make a difference for him. I suspect it will all shake out that he doesn't change jobs til next year, or at least late enough that the distribution will probably be in 2014, but I like the option for him to roll it directly to a Roth and pay the income taxes separately to avoid any tax withholding. I'd even be willing to pay that pittance of tax for him so that he could do this, but I do know that he has enough to be able to handle it.

Did you provide more than half his support for 2013 ?

This is a completely separate question that I also had relative to taxes this year, but I think it works out that he has supported himself since graduation in May, so since he's been living on his own for more than 6 months, I tend to think that he will be claiming himself. I also think it's probably just a bit cleaner to have him do that as his taxes will already be complicated enough since he'll file part-year resident in 2 different states.

Now the other child is a different story. She didn't start her job until September, and she is still living at home, so I have provided more than half of her support in 2013, and expect I will be able to claim her as a dependent this year.

Print the post Back To Top
Author: TMFPMarti Big funky green star, 20000 posts Home Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 119616 of 121144
Subject: Re: question on potential 401k rollover/distribu Date: 12/2/2013 11:19 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 1
Did you provide more than half his support for 2013 ? (These are questions to consider - not nece3ssarily to answer)

Would that life were that simple. Unfortunately Congress, in its infinite wisdom <irony alert>, created the non-uniform uniform definition of a child.

Assuming he's under 24 at the end of the year and didn't graduate before May the first question is whether he was considered a member of your household for more than half the year. (Time away at school counts as time in your household.) If he did he's potentially a "qualifying child." If not, he's potentially a "qualifying relative."

The support test for a qualifying child is whether he provided more than half his own support for the year. The support test for a qualifying relative is whether you provided more than half his support for the year. Gory details available in Pub 501.

Phil
Rule Your Retirement Home Fool

Print the post Back To Top
Author: vkg Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 119617 of 121144
Subject: Re: question on potential 401k rollover/distribu Date: 12/2/2013 11:36 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
If you don't make up that 20% from other funds it's a distribution which may be subject to the 10% penalty.

and his state may add an additional penalty.

Print the post Back To Top
Author: reallyalldone Big funky green star, 20000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 119618 of 121144
Subject: Re: question on potential 401k rollover/distribu Date: 12/2/2013 12:08 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 0
I knew it was complicated - glad you provided the details. The year my older son graduated was a tough year for me and the year my younger son graduated was one followed by another and was a few years ago.

There's another piece to this(the graduation year) that is niggling in the back of my mind - something about Roths or trad IRAs maybe. I'll post if I can remember or find the posts about it.

Print the post Back To Top
UnThreaded | Threaded | Whole Thread (14) | Ignore Thread Prev Thread | Next Thread
Advertisement