Please consult with a financial advisor or tax pro. Today we are sharing a strategy we used with a client to help them reduce their taxable income but still get money into an IRA as they wished.
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The COVID-19 pandemic has forced many Americans to dip into their retirement savings to cover expenses. As a result, the CARES (Coronavirus Aid, Relief, and Economic Security) Act has introduced a provision that allows taxpayers to withdraw up to $100,000 from their 401k without penalty. This is good news for those who may have lost their jobs or experienced reduced income due to the pandemic.
However, taking a 401k withdrawal means you may still owe taxes on those funds. Fortunately, there are some strategies to reduce your taxable income. Here are a few options to consider:
1. Spread out the withdrawal over multiple years: Rather than withdrawing the entire $100,000 in one lump sum, consider spreading it out over multiple years. This can help you avoid jumping into a higher tax bracket in a single year, which would result in a higher tax bill.
2. Contribute to a Traditional IRA: If you have not yet contributed to a Traditional IRA, you can do so before the tax deadline and reduce your taxable income. The maximum contribution limit for 2020 is $6,000 for those under the age of 50, and $7,000 for those over 50. This contribution will offset the taxable income from the 401k withdrawal.
3. Take advantage of deductions: Consider taking advantage of deductions, such as charitable donations, or real estate tax deductions, which can reduce your taxable income.
4. Convert to a Roth IRA: If you have money in a Traditional IRA, consider converting it to a Roth IRA. While you will have to pay taxes on the conversion, a Roth IRA allows tax-free withdrawals during retirement, which can be beneficial in the long term.
It is important to consult with a financial advisor or tax professional before making any decisions regarding a 401k withdrawal or any tax-related matters. With the right strategy, you can reduce your taxable income while still taking advantage of the COVID-19 401k withdrawal provision.
Thanks for the great video! Just wondering your thoughts… for a qualified individual that wants to use this strategy to invest in real estate. Would you say this strategy may not fit them being that they would not be able to write off any real estate losses in the future?
After a little research my employer & Fidelity does not allow lump sum payments into the 457b plan … So, this concept is a bust for me at least. Maybe 401k plans differ.
Ahhhh yesss. Dang now can I do this within the next 4 days is the question haha.
What your take on my situation..I am planning on retirement at 55 years old which is in about a year and half from now. I am tempted to withdraw 100,000 of my 401k or should I wait to I get 55 year old and apply for the 55 year rule. Thanks
If a take a withdrawal, can I just pay the taxes at the time of submission so I don't have to worry about paying later? is there a hidden benefit to this as well, such as more money back for what I continue to contribute?
Is 401k early withdrawal taxed at long term or short term capital gains?
Is this Form 8915-E you were referring to?
Great info!! Coronavirus Related Distributions created many planning opportunities this year. Always have to be thinking outside the box!
After receiving a pay cut, I did this same strategy ("virus rollover") for pretty much the same reason (better choice of investments than what my 401k plan has).
I'll also add that there can be one other reason to do it. For people whose 401k plan does not currently have a Roth 401k option and does not normally allow in-service distributions, this strategy can set them up to be able to do Roth conversions. In my case, i did this "virus rollover" and subsequently also did a Roth conversion roughly equal to the amount of my pay cut this year. As a result, my overall tax bill will come out roughly the same as last year.
Did you say that if he makes over $124K that he get no deduction for contributing to an IRA?
This won't work. The usual 10% early withdrawal penalty is waived this year only under the CARES act if you are directly affected by COVID. The withdrawal itself still counts as a taxable income as does any withdrawal. The CARES act did not change the taxable income part.
Thanks Dustin great advice.
I actually made it in time for the closing beat and then remembered you weren't on today
But the lump sum he is putting is already taxed right ? Cause is money earned not contributed from the 401k . And then u pulled it out ? And have to pay taxes again ? I don’t get it … plus the max u can contribute to Ira is 6k ? Not 10 k … I’m lost
Interesting approach! Is there a limit on the lump sum contribution (I assume it must be no greater than income earned in 2020 or is this capped at the typical 19500/26000 limits)? I know there's a $100k limit on the Covid related withdrawal. This seems like a good way to get 401k controlled money out to an IRA where I can trade options and/or slowly convert to a Roth IRA.
How does buying a house with an IRA work?
But aren't you only about to contribute $6k to the IRA?