I’m 62 and thinking about entire 401k withdrawal for a real estate-buyout. Does anyone know if I’ll have to pay taxes on this withdrawal?
Yes, the total amount will be added to your ordinary income for the year that you take the withdrawal, and will likely bump your marginal bracket to a higher rate.
I would strongly suggest finding another way to finance the buy-out, like taking out a HELOC.
And don’t forget, if the buy-out is due to a divorce, so that you will no longer be MFJ at the end of the year, you will already be paying at the single rates, which are higher for a given amount of income than the MFJ rates. You may want to adjust your withholding.
AJ
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Hi @sfatva,
Depending on the size of the distribution, married/single, state/city of residence, etc, you may end up paying 50% of that money to taxes.
I would talk with a tax expert before doing that.
Does that help you?
Gene
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I will also point out that because your 401(k) is an employer sponsored plan, a minimum of 20% of the distribution amount will be withheld for Federal taxes before you see any money. That means that if you have, say, $100k in your 401(k), the most that could be deposited in your checking account would be $80k, even if you withdrew the entire balance. Your state may require additional withholding, which would further decrease the amount deposited in your checking account.
AJ
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Paying 50% is fairly unlikely, given that the current top Federal bracket is 37%, which would require that state and local taxes be at least an additional 13%. There are a few localities that could impose those rates, like NYC - but to hit those rates there, taxable income before the 401(k) distribution would have to be in excess of $1MM for the entire distribution to be taxed at 50%. Otherwise, some of the distribution would be taxed at lower rates.
AJ
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Thanks for all the info. You are correct and instead of selling, splitting, thinking about alternatives; i.e. buyout. I guess HELOC is also an option. Also, its well below 1MM, and yes, I will no longer be MFJ
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One thing you need to think about if there currently is a jointly signed for mortgage on the house is that the ex should want their name off of the mortgage (and you should want their name off, too, so that you aren’t letting them ride on your credit history), in addition to having it removed from the title. So , you need to check to be sure that the lender is willing to take their name off without having to do a full refi. If you are going to have to do a full refi, then you could roll the buy-out into the first mortgage, too. Even if you’re not forced to do a full refi, you could look at doing one in comparison to carrying a HELOC plus the first mortgage, and see what the difference in cost would be. (And yes, I know that refi rates aren’t great right now, but depending on your current rate and balance, it still might be cheaper.)
I would also suggest the possibility of taking out a 401(k) loan to finance part of the buyout, rather than cashing out the 401(k).
I will also point out that in a divorce, retirement assets, like 401(k)s, IRAs and pensions are often split between the parties. If the ex has some of those assets in their name, you could look at foregoing some of those assets in order for the ex to forego their equity in the house. Or you could give a larger chunk of your 401(k) to the ex, rather than cashing it out. That way the ex will get the tax liability when the 401(k) is cashed out.
AJ
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@aj485 Thanks for info.
Yes, joint title, value 1M, 120k left, 3.25% rate, uncontested, each keeping their 401k.
Yes, HELOC, refi rates are much higher than my original rate.
I’ll have to check into possibility of taking 401k loan 
Okay, that’s $880k in equity, split in half that’s $440k each in equity.
If the 401(k)s (plus any IRAs that you each have) are roughly equal in value, that’s probably a fair thing to do.
If cashing out your 401(k) was going to give you enough to pay the $440k in equity, then you could offer to give the ex some/all of your 401(k), rather than cashing it out. That said, if that will leave you with little/no retirement assets, and just equity in the house, I’d suggest that selling the house and splitting the proceeds would probably be a better option financially. Giving up your 401(k) (either by cashing it out or giving it to the ex) is a set-up for you to become ‘house-poor’, which is not a good place to be as you are looking toward retirement.
A 401(k) loan will only get you a max of $50k, which is a lot less than the equity that it looks like you would need to pay.
AJ
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This is interesting. The ex buying out the house will get the tax liability, and all other expenses, of the house. For example, they will have to pay the capital gains tax when it is sold (with only a $250k exemption as a single filer, rather than a $500k exemption as MFJ). What would their new basis be? And does the other ex, who is bought out, have to declare a capital gain on their half of the house upon being bought out? And, of course, they ex keeping the house is now responsible for all the property taxes, insurance, and maintenance and other assorted costs. I wonder if it might be better to simply sell the house and split the proceeds after all expenses? Then each person can start over fresh.
@aj485 Very helpful input and its much appreciated.
The house has much sentimental value to me and that’s why I was trying to push myself to keep, but seems like you are correct and selling / splitting / keeping 401k intact would be better. This way, I could use the proceeds for a Townhouse (TH) and still have my 401k. Is there an age that 401k can be taken out without any (e.g. federal) taxes? I see that 72 is when RMD needs to be taken and I believe even then, federal taxes have to be paid and no way to reduce/avoid it?? Any suggestions / strategies for this?
I can understand that. We’ve owned one house in our lives, all our kids were born and raised here, all of my siblings have lived within minutes of us and some still do, my parents live right nearby, etc. But we are slowly reaching the point at which it may not make sense for us to keep the house anymore. It has all sorts of expensive repairs, replacements, and maintenance coming. For example, I desperately need a replacement main fridge, and that alone is over $10k (I don’t know why anyone would put in a built-in 48" fridge when the price differential is so high compared to a normal fridge, it’s shocking). And it’ll need a roof in a few years, another $50k.
What is a “TH”?
Unfortunately not. The deal with 401ks is that they allow you to not pay taxes on the way in, but you have to pay all the taxes on the way out (when you withdraw). Recently they added a Roth feature to some 401ks such that you can deposit already taxed money and then not have to pay the taxes on the way out similarly to a Roth IRA.
I think it mostly depends on age. Heck, even the house decision depends on your age to a great extent. If someone in their 40s or early 50s and expect to live in the house for a few decades, then the negatives of keeping it may not matter as much. But if someone is in their late 50s or 60s and will likely leave the house anyway in 5-15 years, then it may really be better selling it now to avoid most of the complications it causes. Basically, you are going to be a single near-or-in-retirement person, do you want to saddle yourself with the high expenses, and assorted headaches, of owning a $1M house for the next 10+ years? Or would you rather live in a very nice condo where you pay others to deal with maintenance, etc? Or maybe even live in a retirement village kind of place where it may be easier to socialize? (I live in Florida where those places are everywhere, and most of the people living there seem to enjoy it)
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One other thing to consider. The price of houses are rather high right now.
Would you be ok with the value dropping after you buy it? Your 401K may drop also, but that’s not costing you $ every month.
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Great forum and thank you all for your feedback
Yes, it’s generally best to sell the house before the divorce is finalized if the loss of the extra $250k in exemption is a consideration. In some areas of the country, it probably wouldn’t be, while in others, it might be.
There is no change in basis - the spouse retaining the house also retains the same basis that the couple previously had.
Generally, no. From IRS Pub 523 - Selling your Home p523.pdf (irs.gov)
AJ
From a financial standpoint, it’s probably not best to mostly/fully empty out your retirement savings and put it into an illiquid asset like a house. From an emotional standpoint, it’s an issue that is the result of the divorce (even if it’s amicable), unfortunately. I would also point out that it’s probably better to close on the sale of the house prior to the finalization of the divorce.
No, for a Traditional (pre-tax) 401(k). (Withdrawals from Roth 401(k)s can be tax-free, but you give up the benefit of the deferring taxes on the contribution amounts.)
The law on RMD age has been updated again. The current RMD age is 73, and beginning in 2033, the age will be updated to 75 - those turning 73 before Dec 31, 2032 will have an RMD age of 73 and those turning 73 on or after Jan 1, 2033 will have an RMD age of 75.
If you roll over your 401(k) into an IRA, beginning at age 70 1/2, you can make Qualified Charitable Distributions (QCDs) directly from the IRA to a charity that qualifies for deductible gifts as a 501(c)3 charity for up to $100k a year. These QCDs will count towards RMDs. Of course, you are giving those QCDs away, rather than using the income for yourself. But you don’t have to count the QCD amount in your AGI, and you don’t have to use Schedule A to deduct the contribution, so you aren’t forced to itemize to get the benefit of the charitable contribution.
You can look at doing conversions to a Roth. That results in paying taxes on the converted amount for the year you do the conversion, but if you have low income years prior to RMDs, then that may result in lower overall taxes being paid.
AJ
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In that case, paying “half the equity” is an absolutely terrible deal. It means that you are paying ALL the capital gains and the ex is paying none of it. That could be a substantial amount of money in many cases. Even in this case, it could be meaningful. Let’s say the house was purchased for $250k, and has $120k remaining on mortgage.
Case 1 - Sell house now for $1M, subtract $50k expenses, subtract $120k mortgage = $830k equity. Capital gain is 1M - $250 - $50 - $100k improvements over the years = $600k. Subtract $500k MFJ exemption, $100k is taxable @ 23.8% = $23.8k tax. Cash remaining after transaction is $830 - 23.8 = $806.2k. Finalize divorce, each gets $403.1k
Case 2 - Pay $440k for half the equity. Sell house later for $1M. Proceeds are $830k (as above). Capital gain is $1M - $250k - $50k - $100k improvements = $600k. Subtract $250k S exemption, $350k is taxable @ 23.8% = $83.3k. Cash remaining is $746.7k subtract $440k = $306.7k. Essentially you get $306k while spouse gets $440k.
Hmm, I bet clever attorneys could come up with some odd combinations to avoid capital gains for a long time. For example, “marry” your future daughter-in-law for a few months, then transfer a house with large capital gains to her in your “divorce”. Later, she marries your son. Or other weird combinations. 
Ouch. Born in 1961, that would mean RMD age of 75 
for me
Yes, thanks to you all, and discussions of capital gain and liable for all capital gain (if buy out), will be better to sell. However, I didn’t understand the part for closing before divorce. What would be the difference?
Bought at 670k, upgrades: 50k (min). Owe: 120k, estimated value: 1M
MFJ exemption: 500k, Single exemption: 250k
It’s easier for both parties to meet the residency and ownership tests for the capital gains exemption if you’re still married when the sale closes. If you will both meet the ownership and residency tests as single people, then closing after the divorce is final would probably be fine. I would suggest that you become familiar with IRS Pub 523 (linked above). There is a section in there on “Separated or Divorced Taxpayers” that will be helpful.
AJ
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Thanks. From Pub 523:
Meet eligibility step 2 (ownership) and step3 (residence)
Meet eligibility step 4 (look back)
For step 5: both meet (joint owner and live in same home for way over 5 years)
Per my reading / understanding of p523, closing, even after divorce is finalized should be fine (I think) since we won’t have much capital-gain (purchased 700k and owe 120k)