In this article we outline thoughts and questions to consider with your tax and financial advisors if you are considering a withdrawal from your 401(k) to pay for your Entry Fee in a CCRC or Life Plan Community.
Please note: While this page is not tax or financial advice, it is meant to give you a good baseline for a conversation with financial professionals who specialize in tax and retirement account management. A few hours of time with a tax or other licensed financial professional could save you a lot of money in unexpected tax consequences.
401(k) Plan Overview
If you are thinking of ways to pay for your Entry Fee to a Life Plan Community or CCRC, you may be considering accessing the funds you have accumulated in a 401(k). Often, the year you move into a retirement community you may consider a larger than average withdrawal to cover your Entry Fees, Purchase, or Deposits. This may create more taxable income. Reviewing the below questions and thoughts with your financial advisor can help you get a head start to smart planning!
What kind of 401(k) do I have?
A 401(k) plan is a retirement savings plan offered by employers that allow the employees to have a percentage of each paycheck paid directly to an investment account. The employer may match part or all of an employee contribution. You can either have a Traditional 401(k) or a Roth 401(k).
What kind of Contributions did I make into my 401(k) plan?
With a Traditional 401(k), employee contributions are made pre-tax, meaning they reduce taxable income, but withdrawals are taxed as ordinary income when made.
With a Roth 401(k), employee contributions do not reduce taxable income, but withdrawals are tax-free when made.
Do I have to make withdrawals from my 401(k)?
Until you reach your Required Beginning Date defined as the date at which you must begin making withdrawals or your Required Minimum Distributions, the earnings and gains within both types of 401(k) accounts are tax deferred.
What is my Required Beginning Date (RBD)?
Age 70 ½ for anyone who reached that age before 12/31/2019;
Age 72 if you reached that age between 1/1/2020 and 12/31/2022;
Age 73 if you reached that age after 1/1/2023.
Age 75 if you reach age 74 after 12/31/2032
The first withdrawal must be made by April 1st of the year following your Required Beginning Date. In subsequent years, your first withdrawal must be made by December 31st of that yea
What is a Required Minimum Distribution (RMD) and how do I know what the minimum distribution should be?
According to the IRS, Required Minimum Distributions (RMDs) are minimum amounts that IRA and retirement plan account owners generally must withdraw annually. For an easy to use calculator that can generally estimate your Required Minimum Distribution (RMD) visit the AARP website at the link provided here.
Please note: No representations are made as to the accuracy of this calculator. Accurate estimates should be provided by a licensed tax or financial professional. By clicking on this link you are leaving the Second Act website:
Things to consider when withdrawing funds from a 401(k)
What portion of my withdrawal will be taxable?
This depends on which of the two types of 401(k) plans you have.
If you have a Traditional 401(k) the contributions you made in the plan were pre-tax. This means the contributions reduced your taxable income in the year you made them. However, when you withdraw the withdrawals are taxed as ordinary income.
If you have a Roth 401(k) the contributions you made did not reduce your taxable income. Thus, when you make withdrawals, your withdrawals are tax-free.
What is the 10% penalty and how can I avoid it?
For Traditional 401(k)’s, a 10% additional tax is applied if you withdraw or use Traditional 401(k) assets before you reach age 59 ½, unless an exception applies: For example, unreimbursed medical expenses that exceed 7.5% of your adjusted gross income.
For Roth 401(k)’s, a 10% penalty applies if you withdraw or use Roth 401(k) assets before you reach age 59 ½ or the Roth 401(k) has not been open for at least 5 years.
What is the 25% penalty and how can I avoid it?
If you do not take any distributions after your Required Beginning Date or the distribution is not large enough, the IRS could impose a 25% excise tax on the amount not distributed as required. This may be reduced to 10% if you correct the missed RMD in a timely manner.
Can I take out a loan against my 401(k)?
You can borrow money from a 401(k), but the amount is limited to the lesser of (1) the greater of $10,000 or 50% of your vested account balance, or (2) $50,000.
Repayment of the loan must occur within 5 years, unless it is for the purchase of the employee’s principal residence.
A loan that is in default is treated as a taxable distribution of the outstanding balance.
Only available to active employees.
Is there a limit to the amount I can withdraw annually from my 401(k)?
There is not a limit to the amount you can withdraw from a 401(k). Although there is no official limit we strongly recommend you review how much to withdraw each year with your tax and/or financial advisors.
Eight questions to ask your tax or financial Advisors before withdrawing from your 401(k) account to pay for your Entry Fee:
1. What kind of 401(k) account do I have?
2. Will my withdrawals be taxable or tax free? As we learned this depends on which type of 401(k) account you have.
3. How much can I withdraw from my 401(k) without going into a higher income tax bracket?
4. If I do go into a higher income tax bracket what is the likely:
(a) additional federal or state income tax?
(b) Medicare surcharge?
(c) additional portion of my social security income that could be taxed?
(d) higher capital gains taxes if I sell stock during the year because I am in a different tax bracket?
5. If I am under 59 ½, do any of the exceptions to the 10% penalty apply?
6. Does my community determine an annual ratio of medical expenses to total expenses that I can share with my accountant? If so, can I use this information to deduct a portion of my entrance fee and/or monthly fee from my income as a medical or other expense?
7. Can I take advantage of this deduction if I do not itemize and simply take the standard deduction? Or do I have to itemize and is it worth itemizing?
8. Do I have more tax-efficient ways to fund my move into my CCRC or Life Plan Community?
A Bridge Loan could be another financing option if withdrawals from retirement accounts are not recommended by your financial advisors.
If after consulting with your tax or financial advisor withdrawing from retirement accounts or selling your securities is not something you want to do, there are other funding options. Second Act provides a Home Equity Line of Credit that can act as a bridge loan to help you pay for your CCRC or Life Plan Community Entry Fees so you can move in first and have the time you need to list and sell your home for the best possible price.
With fast approval, competitive rates, and a special focus on serving seniors, we could help because we understand. Contact us today to learn more about how we can help you navigate your journey to a rewarding retirement.
The information in this page is not meant to serve as financial, tax, or personal financial planning advice. No decisions should be made from reading the information on this page. Decisions should be made after careful analysis and consultation with your financial, tax, accounting, or other professional advisor licensed to provide retirement advice.
Second Act is a Division of Liberty Savings Bank, F.S.B. Member FDIC. Lending and loan services provided by Liberty Savings Bank, F.S.B. NMLS # 408905. Equal Housing Lender. All other services provided by Second Act Financial Services, LLC. This information is current as of 1/01/2023. Subject to credit and loan approval. Conditions and limitations apply. Information, rates and terms are subject to change without notice. © 2023 Second Act Financial Services, LLC. All Rights Reserved.