Q: I am 65 and will be 66 in March. I plan to retire at the end of March. I have about $70,000 in my 401(k). By the time I retire, I will be about $6,000 in debt. I plan on taking money out of my 401(k) to pay off everything I owe so that I will retire debt-free. I understand that I will have to pay income tax on that money. I also want to move some of the 401(k) money into my savings account for unforeseen emergencies. My Social Security check will be about $2,000 a month. I can live on that if I don’t have any credit to pay off.
A: In other columns I’ve warned against large withdrawals that could have a major impact on the income tax rate people might have to pay. This probably won’t be an issue in your case.
The question is what your income and tax rate will be next year. Your income next year will be three months of your current salary, plus nine months of your Social Security benefit. It’s a pretty good bet that your Social Security benefits won’t be subject to income taxes, and that your tax deductions will eliminate any tax liability since you’ll have a personal exemption of $6,200 and a standard deduction (as a single filer) of $3,950, a total of $10,150 in 2014.
And if you do have some amount of taxable income, the first $9,075 is taxed at only 10 percent — so even if you have to pay some taxes, eliminating your credit debt is a good idea.
Q: I’m in a situation I didn’t anticipate but am grateful. Due to my income level (about $190,000), I am not allowed to contribute to my company’s 401(k). There is a shadow/alternate deferred-compensation plan, but I do not plan to retire at this company. I am not allowed to roll over the deferred-compensation amount into a rollover IRA, so I don’t see that plan having any value to me. There is a 2 percent match, but I don’t see that outweighing the fact that I can’t keep this tax-protected once I leave the company.
I’m also above the income level for a Roth IRA, which I discovered after the fact last year. I feel blessed, but I’m not sure what to do for retirement planning until I am working at a new company. What options exist for someone in a situation like mine?
As background facts, I have an existing rollover IRA with about $270,000 and a Roth with about $10,000. (Both are with Vanguard.) My wife has a 401(k) from an old employer with about $10,000 in it. I’ve put about $11,000 in the deferred-compensation plan (before I realized I couldn’t roll it over). I’m married and 40 years old.
Do you have a recommendation on what I should do for retirement options?
R.D., by e-mail
A: It certainly would be nice if you could save on a tax-deferred basis, but you can make the best of the situation by saving after-tax dollars in relatively tax-efficient investments. This suggests that you should invest your after-tax savings in very efficient, broad index funds that invest in equities. A good example would be the iShares Core S&P Total U.S. Stock Market exchange-traded fund (ticker: ITOT). It has an expense ratio of only 0.07 percent. Dividend income from this and similar funds is less than 2 percent a year — and even that is taxed at only 20 percent.
This is very different from funds at the other extreme — managed funds that specialize in a particular area, such as small-cap stocks or large growth stocks.
Building an after-tax investment account can be quite useful for long-term planning and tax management. You need to remember that every dime that comes out of a qualified plan — like a 401(k) plan — is taxable income. In comparison, you can take some money out of a taxable account without any tax consequences if there is no unrealized capital gain. That can come in handy.
SCOTT BURNS is a principal of Plano-based investment firm AssetBuilder Inc. His e-mail address is email@example.com.
— Universal Uclick