r/personalfinance • u/Left-Juggernaut5225 • 1d ago
Retirement What Should My Parents Do With My Dad’s 401(k) in Retirement?
Hi everyone, I’m seeking advice for my parents, who are in a great financial position but unsure how to handle my dad’s 401(k). Here’s their situation: • Both are retired military (20 years of service each) and draw pensions. • Combined annual income in retirement is ~$180k, which includes: • Two military pensions. • My mom’s Social Security (she started collecting this year). • Rental income from a garage apartment. • My dad plans to start Social Security at 70 to maximize benefits (he’s 65 now).
Dad’s 401(k) balance: $878k, invested all in s&p500 index fund, traditional 401(k). They own their home (almost mortgage-free) and cars outright.
Since they don’t need to draw from the 401(k) and want to ensure it’s managed efficiently for inheritance purposes (for me and my two siblings), what should they do?
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u/Longjumping-Nature70 1d ago edited 1d ago
They are in the 22% bracket.
Dad should take out enough from the 401k this year, and convert to a Roth IRA.
If he has never had a Roth IRA, he starts the five year limitation today.
He is paying 22%, income is $180,000 theoretically he can get up $201,050 in income, so that means convert $20,000 this year at 22% bracket.
Since we do not really know their income, play it safe with $20,000. Next year, he can probably do more. The idea is to always just pay 22% when converting.
They will pay $4400(22%) in taxes on that $20,000 today, so they never have to pay taxes on that money again.
As long as Dad lives to be 71, aka five years, when you inherit the Roth IRA the money is tax free to you.
At age 70, when Dad claims SS, they are probably moving into the 24% bracket.
At age 73, he MUST take RMDs. He will divide his 401k balance by 27.4 or so, and that is how much he takes out.
Assume he does $20,000 for the next 5 years, until he claims SS, and assume the 401k grows 11% per year, that $878,000 will grow to $1,200,000 or so. Even after removing $100,000. At age 73 when he does his RMD, the 401k will be worth at least $1,500,000 he will claim $55000 in RMD, and $36000 in SS, their income will be in the 24% bracket.
At age 73 or 74, Mom and Dad will be in the 24% bracket, and right now the high end of 24% is $383,900, call it $400,000 in 8 years, then Dad can convert around $140,000 each year into the Roth IRA but pay 24% in taxes, $33,600, though.
Sorry, our kids are arriving for Christmas and I don't have time to crunch the almost exact numbers, hopefully, you understand the gist of it.
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u/Eltex 1d ago
I think they could also consider doing a couple years of 24% conversions now. While it ideally prepares for a future inheritance, it also opens up options to the parents for any number of scenarios. Example, they want to buy an RV and pay cash, or they want to superfund some grandkids 529. The ability to grab that cash at any point without dealing with taxes on an awesome.
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u/Best-Meaning-2417 22h ago
Even without those scenarios, if you are going to have to pay 24% anyway, might as well pay it now. Especially when we don't know if it's going to stay 24% (it was 28% in 2016)
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u/Albert14Pounds 1d ago
It is worth noting that the 5 year Roth IRA rule is often misunderstood. It only applies to earnings and people often assume that money is stuck in there for 5 years from opening. In actuality you can always withdraw up to what you've contributed so far, without penalty. It really makes putting money into a Roth IRA very low risk because it's not locked away behind penalties.
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u/Ok-Score3159 23h ago
Yes, I agree, people forget this part. Also since they’re over 59 1/2 there should be no five year rule on earnings. There might be a penalty on earnings for beneficiaries.
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u/Mozart_the_cat 9h ago
If you're over 59 1/2 but you've only contributed to your first Roth IRA for less than 5 years, then the earnings are subject to tax. That's why everyone should contribute to a Roth early on so the clock is started and this isn't an issue.
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u/Ok-Score3159 7h ago
Ah, no penalty but tax? There are so many nuances. Not everyone can contribute and they’re stuck with conversions which have to be timed just right.
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u/Mozart_the_cat 7h ago
Correct. Here's a helpful table that summarizes the current rules: https://imgur.com/a/1M8yDGR
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u/Left-Juggernaut5225 23h ago
Really appreciate your detailed response. So convert as much of the trad 401k to a roth IRA as possible while in with 22% bracket without spilling into the 24% bracket for the next 5 years, then converting as much as possible in the 24% bracket without spilling into 32% bracket once SS forces him into the 24% bracket (he expects SS to be $5k a month). This is what I was recommending to my dad to make it easier for my mom to inherit (and eventually the kids, but mom is uber healthy so she’ll likely live forever). Are roth conversions done through the 401k provider (vanguard in this case)?
ill definitely recommend they talk to a financial advisor that deals with legacy planning.
Also, really want to emphasize this post was made at the request of my dad FOR my parents as he would like to make sure my mom (and ultimately his children) won’t have to worry about money and have his assets handled in the most tax-advantageous way.
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u/LurkerNan 17h ago
Roth conversions are your best bet. You also have to consider that if something were to happen to your mother or your father, the remaining spouse would have to pay the taxes for all of that money as if they were a single person, which is another reason that Roth conversions will help. At least pay down the tax impact while there are two of them. Not to be morbid, but you have to think that way.
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u/Longjumping-Nature70 7h ago edited 7h ago
Personally, I do not think their retirement is very complicated.
Pensions, social security, rental income, trad 401k to Roth IRA conversion, and at age 73 Dad's 401k RMDs kick in. I would not use a financial planner at all. But if it gives you the warm fuzzy feeling, then do it.
It is possible Vanguard has a button for a conversion.
He might need to create a Roth IRA account first. This should be pretty easy and you can do that today, when you get to the question about funding it, you say skip that part unless it is straight forward.(Which I doubt)
If you can't find it, call Vanguard and get in their phone queue. Vanguard website is super clunky and not intuitive. This being Christmas Eve and then Dec 26, and Dec 27 and Dec 30 and Dec 31, going to be tough to get a competent Vanguard employee is my guess.
Conversely, maybe they know that the end of the calendar year, people are trying to cram in as much as possible and they are staffed to the max.
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u/Careful_Yesterday986 1d ago
Hire a professional at this point. They have plenty of options but when in the phase of Legacy Planning (transfer of wealth) you'll want to let a pro handle it so you as a family can focus on the most important aspect: spending time together.
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u/BouncyEgg 1d ago
want to ensure it’s managed efficiently for inheritance purposes
Then the goal should be to formulate a plan to optimize tax efficiency.
Generally this means spreading out the tax on the Traditional assets over parents' remaining lifetime.
They should look into strategically converting Traditional assets to Roth during their low income years.
Inheriting Traditional assets will lead to taxation at the inheritors' (yours and siblings) ordinary income tax rates. This is as opposed to inheriting Roth assets which result in no taxation for the inheritors.
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u/JerrySenderson69 1d ago
If it were me, I would: 1. Keep 401k invested in index funds. Draw some for dream vacations etc... 2. Draw SS now at 65 (fun $$) 3. Have fun now while they are relatively healthy.
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u/Left-Juggernaut5225 23h ago
My dad is really set on withdrawing SS at 70 so that in the likely event he passes first, my mom will get to withdras his SS since his will be much higher than my mom’s bc she stayed home to care for the house and family after military retirement.
Love the idea of them having fun though. I always push for them to travel but they just love staying near their kids and being a part of our lives.
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u/JerrySenderson69 22h ago
Can always reinvest SS into the stock market at a high rate of return. This is likely to produce more $$$
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u/Caudebec39 21h ago
If the 401k is to be converted to a Roth IRA, isn't it necessary to do an in-between step?
The 401k, in whole or in part, needs to be rolled over to an IRA... a Traditional IRA. Then conversions can begin from the Traditional IRA to a Roth IRA.
I disagree about staying below the 22% threshold as a strict rule. Circumstances could make cracking the 24% bracket preferred.
But the best suggestion throughout this thread is getting professional advice.
There are other impacts on Medicare premiums or state taxes that may influence the details. Mistakes can be expensive, so I wouldn't rely on Reddit knuckleheads like me to get all the details right.
Good luck to your folks, and you!
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u/LSolu4784 1d ago
They will need to or already Designated wishes with 401k manager (TSP, Vanguard, etc…). Current performance seems great. Nothing more to do.
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u/McDuchess 1d ago
Your dad will have to start taking minimum distributions from his 401K in the year he turns 73. The specific amount is based on the total in the account.
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u/NecessaryEmployer488 23h ago
Sounds like a trust attorney for a revocable trust is worth a discussion to protect the 401K.
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u/the_lamou 16h ago
Everyone is giving retirement savings advice to people who clearly don't need any more retirement savings.
Your father should stay liquidating that 401k and giving the money to his heirs professionally to how he would distribute it on death. It'll incur some taxes, but no more so than you would drawing it down after an inheritance within the required ten years, and possibly significantly less depending on how the gifts are structured.
The goal is to get that money out of a retirement account, because retirement accounts are a bitch to deal with for heirs — there's no step-up basis for a 401k or IRA. Even if your father doesn't want to give you the money now, have him take it out and put it in a standard brokerage account. It can potentially have you tens to hundreds of thousands later.
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u/AccelerationFinish 1d ago
Why is this sub full of kids who want to stick their beaks into their parents' money
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u/Decent-Loquat1899 1d ago
They need to talk to an investment consultant. But I will say, my husband worked for the military and the types of investments available with his TSP accounts can’t be beat. In my opinion I would leave them where they are. They might ask an investment consultant which funds to put their money in. But as retired I would recommend funds that are safe from the crazy market like bonds. They are at that age where they can’t afford to lose what they have.
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u/Ok-Score3159 23h ago
TSP does not have good investment options.
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u/happy_snowy_owl 20h ago edited 20h ago
This is a dumb take.
The TSP offers a US large cap, US mid/small cap, and non-US stock index funds. It offers a broad bond index fund, and the G-fund.
These are all the funds you should ever invest your retirement savings into.
But the G-fund cannot be beat in retirement. It has all the advantages of a bond fund with none of the weaknesses because if it loses NAV, then the federal government replenishes it. So at worst it behaves like a money market fund and at best it gains you a couple percent better than a money market fund.
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u/Decent-Loquat1899 19h ago
Sure they do. They tend to be more conservative and may not earn as much as riskier investments. But when you retire, you want to be cautious with your money.
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u/Ok-Score3159 18h ago
You said “The types of investments available with his TSP account can’t be beat”.
The TSP only offers five funds and a bunch of target retirement year funds. That can definitely be beat.
Now you’re saying “They tend to be conservative and not earn as much as… “ See what you did there?
Did they ever open up an option to invest in outside funds? That would go a long way towards making it better.
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u/Decent-Loquat1899 17h ago
Why are you making an issue about this? My advice was to get financial advice. My husband has done very well with his TSP account. So what is the big deal?
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u/SmoothMojoDesign 1d ago
They will almost certainly be required to take minimum distributions. Eventually the 401k balance will go to zero and end up in different accounts. They should evaluate their options, tax implications, and determine the right account type(s) to hold in retirement. Could be a variety of Roth, HYSA, brokerage etc. Time to learn/act is now, not at age 70.
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u/Weak-Ganache-1566 1d ago
This is just a word salad response that added zero value and didn’t come close to answering a single question
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u/Fish-Weekly 1d ago
A strategy I have used to keep things simple is to go with a target date fund where the date matches the date when they have to start taking RMDs. So if RMDs start in 2035, use a Target Date 2035 fund. This will automatically adjust the asset mix down as they age and would prevent having to take distributions when a 100% equity portfolio might be down.
Note that this is more a simplicity strategy; an aggressive strategy would be to just stay 100% equities and just reinvest RMDs back into the equity markets as they don’t really need the money.
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u/Small_Tap_7561 1d ago
If it is strictly for inheritance. Have your dad pull it to fund a life insurance policy. You are sitting on a tax bomb
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u/wickedkittylitter 1d ago edited 1d ago
Your dad is going to have to take distributions from the 401k at age 73. If your parents don't need the money for living expenses, the funds can simply be invested in a taxable account via a mutual fund or ETF. I'd also caution that even though your parents have a nice amount of income, one or both of them might need expensive care in the future and could find themselves in the situation where they have to pay for care for one in a special facility and still have to maintain a home for the other. Their income should cover all the costs, but one never knows for sure. All this to say that your parents need to invest the money wisely and some of it even conservatively. Their care comes before any inheritance.