If I withdraw some of what I contributed to my Roth in 2023, will I lose that proportion of the savers’ credit for 2023, or is that unaffected? Do I even have to mention it to my accountant? The account is long term, more than five years (a lot more!), and I want to take out some of last year’s contribution because I have done well in the market last year (and this year so far) and could use the withdrawal for some unexpected expenses. It would involve taking out quite a bit of the contribution, about 75%.
From what I understand, I have a right to take out what I contributed (perhaps even before five years, but I am over five years) at any time, but it’s what happens with the tax deduction I am curious about. Thank you…(wait a sec, because I just checked to the side as I was writing this…a suggested similar post came up, about a 401 k rollover…actually, this Roth I want to take from was indeed a 401 k rollover that became first an IRA, and then, just two years ago, not five, was rolled over into a converted Roth…when I made the contributions in 2023, it was a Roth, just to be clear, but it has not been open five years…however, I have another Roth account at a different brokerage that has been open way longer than five years…does that Roth somehow exert a legal influence over the newer Roth and shield me from any tax consequences? I mention all this additional stuff in case it matters.)
Yes, if you take the withdrawal before the due date (including extensions) for your 2023 tax return, that withdrawal amount will no longer be counted as a contribution amount toward the saver’s credit. See IRS Form 8880 2023 Form 8880 (irs.gov), specifically line 4 and the instructions for that line.
It will also affect your saver’s credit calculations for 2024 - 2026, because there is a look-back.
I wanted to clear up some misunderstandings here, separate from the Saver’s credit discussion.
IRA stands for “Individual Retirement Arrangement”, not “Individual Retirement Account”. All of your IRA accounts are considered to be a part of this arrangement, and therefore the IRS considers them to be consolidated when looking at things like withdrawals.
There is no 5 year clock on taking out regular (not conversion) contributions from a Roth IRA to avoid taxes and penalties. You can take that contribution back out as soon as your broker lets you. (Since IRA contributions must be made in cash, generally brokers have settlement requirements of a few days for cash deposits from another institution. If you were holding the cash contributed at the broker, you may be able to take the contribution amount immediately.) However, taking into consideration #1, if you have Roth IRA accounts at two different brokers, you can make a Roth IRA contribution at one broker and immediately take that amount out of the Roth IRA at the other broker without incurring taxes or penalties.
There is a 5-year clock on conversion contributions to a Roth. If you withdraw converted amounts before they have been in a Roth account for at least 5 years, and your withdrawal is not a qualified withdrawal and does not meet any other exception, you will be hit with a 10% early withdrawal penalty.
Further, if your Roth withdrawal is not a qualified withdrawal and does not meet any other exception, any earnings included in that withdrawal will be taxed, in addition to the early withdrawal penalty.
IRS Publication 590-B 2022 Publication 590-B (irs.gov) provides the requirements for qualified withdrawals, exceptions to the early withdrawal penalty and the ordering rules for distributions that are not qualified.
None of these withdrawal rules mitigate the how the Saver’s credit considers withdrawals when calculating the credit you get.
I tried to answer the question earlier, but not being an expert, I had to look it up. And I couldn’t find a definitive answer to a critical (I think) question.
How do you identify which original Roth contribution you are withdrawing? If this Roth has been around for, let’s say, 10 years, and the contributions were as follows:
2014 - $2000
2015 - $2000
2016 - $4000
2017 - $3000
2018 - $5000
2019 - $6000
2020 - $6000
2021 - $7000 (became eligible for catch up contribution)
2022 - $7000
2023 - $7500
Now come early 2024 and you need to withdraw $4000 of your contributions. How do you identify which contribution you are withdrawing? Is it LIFO, last-in first-out? Or can you choose to withdraw the 2014 and 2015 contribution instead of the 2023 contribution? And in that case, it wouldn’t affect the saver’s credit. Or does the savers credit get reduced by ANY contribution withdrawal from any of the previous years.
Thank you AJ for all this…it is very helpful, and I will tell my accountant as you advise. Question though: what exactly is a conversion? How do I know if I have conversions in the account?
Mark, that never occurred to me. I look forward to that answer as well.
You don’t need to identify any specific contribution. At least not with these given facts. Contributions are just one big pool you draw from.
There used to be a little potential benefit of withdrawing a current year contribution if one was available, but I’m pretty sure that loophole was closed a few years ago.
You don’t. You aggregate all Roth contributions when using the ordering rules. The reason I was referring to a particular year when I was discussing the timing on withdrawing a contribution was because it’s possible that all previous contributions had already been withdrawn.
It actually gets reduced by ANY qualified retirement plan withdrawal - Roth, Traditional, 401(k), TSP, etc., plus withdrawals from some other types of accounts. From the instructions on Form 8880 2023 Form 8880 (irs.gov)
BTW, I would recommend telling your accountant BEFORE you take the withdrawal, as it has implications for claiming a saver’s credit for 2023 - 2026. Your accountant may be able to suggest another source for the funds you need.
Also - have you looked at taking a loan from your 401(k)?
I have not checked on a 401 loan, primarily because my thinking was I could pay myself back to the Roth with no interest. Besides that, I am fairly sure I could not qualify for the loan under my company’s rules (or any govt rules)
Well, if you haven’t done another 60 day rollover within the last 365 days, and you could pay back the Roth IRA in full within 60 days, then you could do so without paying interest and/or impacting your saver’s credit. But any part of the withdrawal that is not paid back within 60 days will impact your saver’s credit for 2023 - 2026, which will could potentially cost a lot more than any interest you would paid. So be sure you will have the funds to pay it back within 60 days.
The government rules for taking out a 401(k) loan are pretty minimal. All you have to do is have a vested amount in the plan that’s at least twice as much as the amount that you want to take out, you can’t have taken out 2 loans in the last year and you can’t take out more than a total of $50k. I haven’t ever seen a 401(k) plan that offers loans require anything more than the government rules, so I’m not sure what your company would require in addition to those rules. Are you sure you’re not thinking of hardship withdrawal rules for 401(k)s? That’s totally different than a 401(k) loan.
If you haven’t done another 60 rollover in the past 365 days, you can put the money back in within 60 days of withdrawing.
I’ve always considered this more “undoing the withdrawal” rather than “paying oneself back” (as is done with a 401k loan). But I’d guess that there are some scenarios where having access to that money for under 60 days could be a wise thing to do. For example, if the only alternative is an expensive payday loan, then perhaps taking a few hundred bucks out of one’s IRA for a few weeks is a better choice.
Yes, but I’m always skeptical that someone who doesn’t have the money now and would have to resort to a payday loan (or even paying interest on a credit card) will actually have the money to pay back the IRA in 60 days. I’m sure that there are cases where that can happen, but I’m also sure that some (many?) people who attempt this are counting on money that never arrives and end up with a withdrawal from their IRA instead of doing a 60 day rollover.
I’ve never seen actual stats, but I wouldn’t be surprised if a majority of people who withdraw retirement funds early end up not replacing the money. I wouldn’t even be surprised if this also included 401k loans; Someone takes a loan, begins paying it back over a 5-year period via payroll deductions, loses their job or otherwise changes jobs, stops repayments, and it becomes a taxable withdrawal plus penalty in some cases.
THIS is why is is almost always advisable to NOT take money out of retirement funds until retirement. There are all sorts of adages about it (“you can’t borrow to fund retirement”, etc).
I don’t agree with you that the majority of people taking out 401(k) loans aren’t paying them back. As long as the employee continues to be employed, the payments are taken out of their paychecks automatically. Then, I will point out that the law has been changed to require that 401(k) loans can be continued to be paid down/off under the original terms even after the employee leaves their job - either voluntarily or involuntarily. So even if they leave their job, they have the opportunity to pay it back, and at least some will. I know that because while I was employed, I took out and paid off several 401(k) loans, including at least two that I continued to pay on after I left that job.
Maybe. It depends on one’s specific circumstances. In my case, I replaced some of the bond portion of my allocation with the 401(k) loans and the 401(k) loans allowed me to borrow money without having to pay interest to a lender. Rather, the interest paid went into my 401(k) balance.
I don’t assert that a majority do so, only that if it were so, I wouldn’t be surprised. Turns out that only 37% default on their loans over a 5-year period. And as intuited, of the ones who default, 86% did so after leaving their company. To be fair, this is based on old data, before the law was changed, so no doubt the numbers are lower now.
That only works if your employer doesn’t have any “punitive” rules when taking out a loan. For example, some plans don’t allow contributions while a loan is outstanding. Not sure if that is still permitted though under new law. And, obviously, “without having to pay interest to a lender” is literally accurate, but in reality, you are still “paying” in a way, because whatever that money was earning inside the 401k, stops when the loan is taken and the money is withdrawn. For example, if over the 5 year period, it would have been invested in the S&P500 fund, and earn 8% a year, and instead you pay 6% interest, the 401k value is still out the difference of that 2% extra. Not to mention that the 6% interest has to paid with after-tax money, and will be taxed again upon withdrawal when drawing retirement funds from the 401k. Can you borrow from a roth 401k and pay interest into it?
Oh, I also read that the new 2020 law (CARES act) raised the maximum loan to $100k from $50k. Is that accurate?
You know, I’ve heard that a lot. But I’ve never had anyone actually provide me an example of a plan that actually does that. None of my 10+ plans during my career had any restrictions like that. So, I’m skeptical.
Except you’re “earning” the interest that you’re paying yourself, in lieu of getting earnings on the principal amount. If you substitute the loan as a part of your bond portfolio, you’re probably going to earn a similar amount.
Which is why you need to substitute your loan balance for a part of your bond allocation.
Of course, on the other hand, if the S&P loses money over the time that you are holding the loan, you come out ahead.
The only potential ‘double taxation’ is on the interest, because you have to account for the offsetting benefit of getting the loan principal amount without paying any taxes on it. That said, the double-taxation is a red herring. Because taxes are paid on income, and nothing about the loan - taking it out or paying it back - changes anything about your income, there is no change in the taxes that you pay, so where is the ‘double-taxation’?
The plan would have to allow it. The government doesn’t prohibit it.
I agree that it doesn’t change anything in reality or financially. Because if you took an equivalent loan from a bank instead, you would still be paying THAT interest with taxed money. But it still doesn’t feel good knowing that you paid tax on some money, then used that money to pay yourself back inside your 401k, and because of the way the 401k works, when you withdraw it in a few years, you will pay tax on that money again. Normally, if you contribute already taxed money to a [traditional] 401k, then that portion of the money isn’t taxed on the way out (but it does mightily complicate your calculations thereafter!)
