In a previous article we talked about our Cares Act withdrawals from our 401ks for 2020. My wife’s employer reduced her salary in 2020 as a precautionary measure, which made us both eligible to take up to $100K from each of our 401k accounts without the usual 10% penalty. The money would be taxed as ordinary income, but we decided to both take the maximum $100K withdrawal.
Most of our nest egg is in tax-sheltered accounts, so there are restrictions to access the funds prior to reaching age 59 1/2. We are working on adding to our investments in taxable accounts to increase our passive income that we could use to fund our “early” retirement before reaching age 59 1/2. We are currently in our late 40s, so could need several years of expenses before tapping tax-sheltered funds and social security, depending on when we pull the retirement trigger.
In parallel, we are looking at various ways to to tap tax-sheltered accounts prior to reaching 59 1/2 while minimizing or even eliminating the penalties (usually a 10% fee on top of taxes owed). These options include the following:
This Cares Act Withdrawal is essentially an option to do exactly what we are trying to do! The articles I have read about the Cares Act withdrawal and tapping tax-sheltered accounts generally say that tapping retirement funds is a last resort and should be avoided at all costs. This is to avoid depleting funds that will be needed once we reach retirement. In our case, we are looking to reinvest into our taxable accounts to supercharge our passive income. It is intended to reallocate more to our taxable accounts and also to help support our aggressive savings budget. Maybe we can use some to do the home improvements we have put off for so many years.
Furthermore, our plan is to replenish the funds in our 401ks over three years. The Cares Act allows us to spread out the income over 3 years, and also provides the option to repay the withdrawal within the 3 year period. If we can re-contribute the funds before filing our taxes for each year, there is no additional tax liability for that year. If we repay after filling taxes, we can still recoup the money, but would need to file an amended return. Of course, this is a daunting task, but it is like our aggressive savings budget that we have covered before. As my mother had taught me, it’s challenging and will require “delayed gratification“, but it is worth it to “pay yourself first“.
Now, with that being said, life happens and we ran into unexpected house expenses recently, but this is what an emergency fund is for! Conventional wisdom is to have 3 months of expenses sitting in “cash“, but preferably 6 months or more to handle these costs. Still, the expenses along with repaying $60K of the $200K has left us less flush with cash than we would like. I just finished filing our taxes and was expecting a tax bill of $10K or so, which would make it even worse.
In the last article, I mentioned that in February when I started entering our taxes in Turbo Tax, things were evolving in real-time. Turbo Tax could not account for the Cares Act withdrawal correctly, and it said we owed approximately $65K in taxes!! I nearly had a heart attack, but it had a message to try back later when the calculations could be updated.
When logged back in recently to complete our taxes, I realized that Fidelity had withheld $10K for federal taxes and $5K for state taxes on each withdrawal ($30K total). We had repaid $30K each ($60K total) of the withdrawal before filing taxes, so our tax liability on the withdrawal for 2020 was $0. Instead of owing $10K, we were actually getting a $20K refund between state and federal! This is exactly what we needed to help refill the coffers. This is good, because it is going to be tough to repay the next installment (another 60K) for 2021. It will be important, because we will have “used up” the withholding from the initial withdrawal, since it became our refund. Also, in 2021 my wife’s company repaid her lost wages from 2020, so our income will be higher than last year too.
It is nice to get a tax refund, have not received one in many years, but it is just our own money getting returned to us. I have had colleagues and family tell me that they look forward to their tax refund so they can buy something or repay a debt, but in general you would be better off having the money over the course of the year. You could invest it and earn interest, but if it works as a forced saving plan that may be better than just spending it.
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| Disclaimer: I am not a financial planner and content on this site is meant to provide food for thought, not professional advice. I share my experiences to show what worked so far and what didn’t, YMMV. Please consult your financial advisor or tax professional as needed. |
