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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 75375  
Subject: Re: Leave in 401(K) or rollover to IRA? Date: 9/2/1999 4:47 PM
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Your quote is from PIXY who doesn't advocate LSD for anyone because they don't apply to everyone. since I started the subject, I'll answer you.

PIXY's quote:

"If your spouse was over the age of 55 on separation, if you are in a 31%
marginal tax bracket today and expect to stay there, and if you have no need
for the cash in retirement, then you could cash out today to enjoy a
minimum income tax burden on your family over your lifetime.

She has to be at least 59 1/2 this year, and 65 if next year. She can be in the 28% bracket. She can spend the money. She will pay no taxes on this money thereafter. Other facts and sssumption could make this a plus or minus choice. The factors get positive for lesser amounts to LSD, higher individual tax brackets for the retiree and his spouse and his heirs, larger estates, less need to spend the funds after the LSD, longer participation in the plan.

Let me see if I understand some of this.
By taking a lump sum distribution the taxes would be
less than 20% for cap gains.


Forget CG now. I'll get into that later.

The advantage is a smaller tax hit today
versus a longer and higher tax hit in the future - assuming that my MTR
stays at 31%.


Even if it drops to 28%.

I am not sure I understand the comment about not needing cash in
retirement. An example might help me.

Let's say I take a $500,000 lumpsum distribution and
pay the 15% tax or ($75,000).


You'll pay about $128,000 tax on a $500K LSD. That's about a 26% average tax rate.

Doesn't this now make any investment from
the $425,000 my new basis. If I left it and took it on a yearly basis, I'd be
paying 31% in taxes.


Yes, the net $372,000 is all after tax investment money. If you took the $500K out at 31% you'd only have $345,000 to invest (or spend)

Is the concern the loss of the 401K or IRA tax shelter for future returns?

Yes. any tax paid on growth or income from the LSD funds cuts into the above $27,000 tax profit.

First the capital gains:

1. If the plan is an ESOP the LSD is on the difference between the exercise price and FMV. Then you sell the stock a year later and pay normal LTCG (20%) tax on that profit.
2. If you ahve been in the plan over 25 years you get "pre 1974 CG treatment". For instance if you participated for 50 years 1/2 the above $500K gets a flat 20% tax rate ($50,000) and the remainder is only taxed about $50,000 for a total of $100,000 LSD tax, or 20%.

On the original $500K of pension your "Profit" for an LSD is 31% - 26% or 5%. If you funds grew 33% and you had to spend them all, 1/4 of them would be taxed at LTCG rates of 20%, exactly eating up your profit.

However, if you had been in the plan 50 years, your profit is 11%. Your post LSD funds could double and you spend them all and still be slightly ahead.

Looking at the bright side (of the choice not the tax) if you DIDN'T have to spend the funds you'd have $1 mil of pension funds in your estate after they doubled, (assuming you died before age 70 1/2 and hadn't withdrawn anything), and at 26% LSD rates, $740,000 of after taxed LSD funds. At 50%, the FET on the $1 mil would be $500,000 versus only $370,000 on the LSD funds, saving $128,000 (plus the spread of 5% on the $1 mil, or $50,000. The heirs may have to liquidate the IRA (if it had been rolled over, and can't do a LSD on the 401k anymore) FAST at possibly the 39.6% bracket just to pay the FET. So the spread may even be greater. The potential savings to the heirs may be as much as $128K + $50K + another $86K = $264,000 (plus another $26K if it was the 50 year participation).
What was marginal on one assumption can turn into a $1/4 mil inheritance under other circumstances.

Hence, do not make snap judgements as to the inadvisability of an LSD for anyone until you have researched all the possible factors

Is it possible to take a Lump Sum and roll that into
a ROTH which shelters future gains and withdrawal from taxes?
BGP


No you can only roll over an IRA to a Roth and that's at your current tax bracket. If you use an LSD you have to make the post LSD funds LOOK like a Roth by investing in a tax managed index fund and hopefully not have to even spend the growth in it till you get a step-up in basis at death.
I hope this helps you . Ed
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