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When you quit your hateful job 59 1/2 and start
living off your sizable 401k, you will be paying
taxes on the 401k disbursements. What gain
calculation methods are available for calculating
the tax liability in this case?

It seems that the only viable alternative is "average
cost" since most 401k statements aren't Foolish enough
to provide a complete transaction history -- thereby
eliminating anything but the average cost method.

But my foolish head tells me that "average cost" would
most likely *not* be the best choice since some "old"
shares might substantial gains and some "new" shares
might have small gains.

Can any Fools set me straight on this?
Is this a fact of life with 401k accounts,
or am I misinformed?

Thanks!
AitFool

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When you quit your hateful job 59 1/2 and start
living off your sizable 401k, you will be paying
taxes on the 401k disbursements. What gain
calculation methods are available for calculating
the tax liability in this case?


I hope the size of the 401k was a worthwhile trade for a job you hated. And don't forget that the majority of the money in the 401k is YOUR money that you choose to save for retirement. Very few companies offer 100% matching funds.

</rant>

As far as taxation goes, it's pretty simple. You pay ordinary income tax on whatever you take out. There's no capital gains issues here.

UNLESS -- you chose to have your employer's securities distributed to you. Then you pay ordinary tax on a part of the value and then that becomes your basis for capital gains or losses when the stock is sold. Only your employer can provide that information - and they will at the time you take the distribution.

--Peter
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I think it just hit me... since the money you put in was pretax, your cost basis as far as taxation goes is $0/share so, as you said, you'll be taxed on what you take out and not on the gains over what you put in.

Is that right? I was thinking you should be able to identify specific lots and stuff to figure the gains.... but it doesn't really matter since you've never paid taxes on any of the money in the 401k.

AitFool

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<<I think it just hit me... since the money you put in was pretax, your cost basis as far as taxation goes is $0/share so, as you said, you'll be taxed on what you take out and not on the gains over what you put in.>>

Bingo!! Absolutely correct. Your basis on pre-tax dollars is zero. And you'll be taxed at ordinary rates when you take distributions.

<<I was thinking you should be able to identify specific lots and stuff to figure the gains.... but it doesn't really matter since you've never paid taxes on any of the money in the 401k.>>

You've got it down cold. Perfect.

The ONLY exception is when the 401k invests in YOUR company's stock, and you take a distribution of the stock. There is a method by which you can take the stock and pay capital gains rates on the appreciation. That very issue has been discussed here (just recently, as I recall). And I also know that TMF Pixy (Dave Braze) has also written articles on this issue in the retirement section. So if this applies to you, you might want to check it out.

TMF Taxes
Roy

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I think it just hit me... since the money you put in was pretax, your cost basis as far as taxation goes is $0/share so, as you said, you'll be taxed on what you take out and not on the gains over what you put in.

Is that right?


Yep. Sounds like the light bulb just turned on. ;-)

And just to be sure - it will all be ordinary income, not capital gains. Remember that the pre-tax money that went into the 401k was wages - ordinary income.

--Peter
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