Tax-free alternative to 401(k)?
Question: Hi Chris, Really enjoy your show. I am a retired military living in Germany. I’m presently approaching 66 years old and am told I must cash in my 401K savings by age 70 1/2, which means they would then become part of my taxable income. Are there any programs out there which would allow me to move my pre-tax 401K savings to some other type of pre-tax savings program? Also, I heard a rumor that there is an initiative to extend the age limit past 70-1/2; have you heard anything to that effect? Leonard, Selzen DE
Answer: Thanks. When I was growing up we lived in Bremerhaven, Germany, for several years, and I went to the elementary school on the base. When I was a merchant seaman after graduating from college my first ship used to dock at Bremerhaven, and I got to revisit our old haunts. Anyway, you don’t have to cash in all the savings in your 401(k). You just withdraw the amount you need and pay your ordinary federal income tax rate on the withdrawal. The remaining money continues to compound tax free. And, yes, at age 70-1/2 you are required to start taking your minimum required distribution.
The bottom line is that Uncle Sam is going to get paid. You could make a tax free transfer of the money from the 401(k) plan into a traditional IRA, but the same tax and required minimum distribution rules apply.
Now, there is no required minimum distribution with a Roth-IRA. You could convert the 401(k) into a Roth-IRA. The law has been changed so that you can roll a 401(k) straight into a Roth. But you’ll pay taxes on the conversion. Remember, before 2010 you’re adjusted gross income has to be below $100,000 to make a conversion. You also can’t touch the money for 5 years. My guess is that the numbers won’t push you toward the Roth option, though, but you could check it out.
One important thing to note: at the moment there is a one-year moratorium on required withdrawals from retirement savings plans for anyone 70-1/2 or older. It’s only for 2009, and then the rule comes back in force in 2010. The idea is to buy some time for those retirees with battered portfolios. Although I think the whole retirement savings system will be looked at closely over the next several years, and that reforms will come, I’m skeptical that there will be any wholesale change in the distribution rules. The federal government will need the tax revenue in light of budget deficits as far as the eye can see.
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