401 K withdrawals

bmmaloneOctober 17, 2009

my husband needs to make a withdrawal from his 401K. He was laid off last year and the 401K is still with his old company. He can do this without penalty because of his age, but his company says he will have to take all or nothing. If he takes 'all', can he then roll some of the money into an IRA, but keep a portion for himself. Also if you take a withdrawal, I know you are liable for income tax, but is there anything else that you would be liable for?

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jkom51

Roll the old 401k into a Regular IRA at a low-cost, discount brokerage. Then he can start taking withdrawals, and will pay taxes only on the withdrawal amount.

There are no other issues, except that the first statement you get from the brokerage will have your cost basis information. This should be kept with your legal papers, just in case there is an issue about gains appreciation if he dies and the beneficiary needs this info for tax purposes. Many people are under the mistaken impression that the brokerages keep this information - they DO NOT, so decades later when the heirs need this info, it often cannot be found in the estate's paperwork.

    Bookmark   October 17, 2009 at 5:18PM
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bmmalone

My husband can take the 401K withdrawal without penalty because of his age and the fact he was laid off in his 55th year. If we roll this into an IRA can he still take withdrawals at age 56? He is in the process of starting his own business and our savings are nearly gone (its taken 16 months to go through them so we did ok) and we could really do with a 'lump sum' to tide us over until March of next year when (hopefully)money will start coming in from the new company.

    Bookmark   October 17, 2009 at 9:49PM
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sushipup1

The caveat here is to make arrangements with the new company first, and do not take a payment directly to yourself. Call Schwab or Vanguard or Fidelity and they will walk you thru the entire process.

    Bookmark   October 18, 2009 at 12:18AM
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jkom51

The only way he can take withdrawals after FIRST setting up the IRA, is to use the rule of 72T. Consult a tax advisor for specific details - there's some pros and cons to doing this.

    Bookmark   October 18, 2009 at 3:35AM
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maime

You need to check with your accountant. When my husband retired we cashed in his retirement IRA. My accountant figured it 5 ways, explained them all, then we made the decision. We opted for a 10 year averaging and we got of lot of the taxes back when we filed. If we had left it in an IRA and my husband died I would have to pay taxes at a higher single rate than we did when we cashed it in.

    Bookmark   October 18, 2009 at 4:47PM
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bethesdamadman

jkom: "There are no other issues, except that the first statement you get from the brokerage will have your cost basis information. This should be kept with your legal papers, just in case there is an issue about gains appreciation if he dies and the beneficiary needs this info for tax purposes. Many people are under the mistaken impression that the brokerages keep this information - they DO NOT, so decades later when the heirs need this info, it often cannot be found in the estate's paperwork."

Jkom, I am unaware of any reason to keep cost basis information for assets within a tax-sheltered account such as an IRA, even in inheritance situations. Could you elaborate?

    Bookmark   October 19, 2009 at 6:24AM
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jkom51

Keeping the cost basis is one of those iffy little things that you probably do not need - but it actually does come up in rare situations. When I was an admin at a CFP's office, we encountered this situation and could not help the client. He'd lost his cost basis info and the brokerage holding the assets could not help him as this was a situation dating back almost 20 yrs ago.

I believe it arises in two situations: if you've made some after-tax contributions to a 401k (this has happened to my DH as well, in donating unused vacation time to his 401k), or if you're a high wage earner and contributed to a 401k even though you could claim no tax deduction for that year.

Because the client had lost his original cost basis info, the IRS assumed that all his contributions were made pre-tax, and taxed his withdrawals a second time. His original employer had gone bankrupt and there were no company records we could easily find to validate his occasional post-tax contributions. He was trying to just withdraw his post-tax dollars, but without documentation the entire account was classified as all pre-tax $$$.

    Bookmark   October 19, 2009 at 8:05PM
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jkom51

And here's an article (excerpted) that just showed up today in the WSJ. Many people hold stock in their 401ks, so this does seem a potential issue. There is simply no telling what the income tax and capital gains rates are going to be at the date of your death, so keeping at least these minimal records (cost basis) certainly wouldn't hurt. The article goes on to point out that Congress can make retroactive changes in the estate tax laws; it's been proven legal as the IRS won the two cases filed against them.

Will the Estate Tax Disappear?
Changes in the Way Inherited Assets Are Valued Could Cost Heirs and Cause Hassles
WSJournal October 22, 2009

Many people hope the federal estate tax will disappear next year, as scheduled. They could be sorry if it does.

Back in 2000, Congress enacted a gradual loosening of the estate exemption. It has since risen to its current level of $3.5 million per individual, or up to $7 million per couple. The tax is scheduled to lapse just for next year and return in 2011.

Washington insiders are betting lawmakers won't let that happen. Instead they believe Congress is likely to act before the end of this year to extend the current system through next year. And perhaps they should, because getting rid of the estate tax actually would cause problems for most taxpayers.

At issue is the "step-up in cost basis" that all assets receive when an owner dies. The way the law is currently written, if the estate tax goes away, so does the step-up in cost basis. That's where the problem lies.

Step-up means that the property heirs receive is valued as of the date of death. So if Grandma leaves a grandchild stock selling for $75 a share that was bought in 1970 for $2 per share, the heir's "cost basis" in the stock is $75. If the grandchild then sells the stock for $80, the taxable gain is $5 per share. The same holds true for both real estate and personal property, like an heirloom ring or art.

If Congress fails to extend the current system for 2010, then at the owner's death all assets would retain their original cost, called "carry-over basis." Under this system the heir's stock would have a cost basis of the original $2 per share rather than $75. If he then sells the stock at $80, the taxable gain would be $73 instead of $5Âa huge difference.

For most heirs the switch to carry-over basis would mean paying far more in extra income taxes than is due under the current estate tax system. Currently only about 5,500 estates are federally taxable each year, because is exemption is fairly high. Carry-over basis would also pose a massive record-keeping burden, forcing multiple generations of taxpayers to keep documents over many decades.

    Bookmark   October 23, 2009 at 12:42PM
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