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I found a way to withdraw from 401k without paying taxes! :)

Storyteller 414 February 9, 2011 at 07:12 AM in Finance (3)
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I could be dead wrong on this one, but I think I've just hacked the 401k. Wink

First, here's the 401k concept in a nutshell, at least the way I understand it: the money that you make and put in your 401k is not taxed. If you make $45,000 and put $15,000 in your 401k, you'll be taxed on only the remaining $30,000. The money in your 401k is taxed only when you withdraw it, either before you're 59.5 years old (in which case you pay a 10% early withdrawal penalty), or after. In either case, the money is treated as profit and is taxed accordingly. Am I right so far?

Now, here is my idea: the foreign-based income exclusion rule states that you don't have to pay income tax on the first $92,900 you'll earn while living abroad, provided you are "physically present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months (source-1 [irs.gov], source-2 [irs.gov]). To me, this seems like a perfect opportunity to avoid paying any taxes on your 401k earnings. It's so simple: wait until you're 59.5 years old, move someplace fun, cheap and foreign (Argentina?), spend most of the year there, withdraw $92,900 from your 401k and voila! - tax-free income. Cool Of course, there are a number of restrictions and requirements put forth by the IRS, but it seems doable. If you're not yet 59.5, you'll still end up paying only a 10% early withdrawal penalty, and nothing more. Seeing how most of us pay a lot more than 10% in income tax, this seems like a ridiculously good deal. If you have more than $90K in your 401k, you may have to spend more than one year abroad to maximize the tax advantage. And it's quite a big advantage, too: if you were to withdraw $92,900 without bothering to become an expatriate, you'd end up paying $19,721 in taxes. (source [moneychimp.com])

So, did I get anything wrong or did I just come up with the most amazing retirement hack ever? laugh out loud

35 Comments

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#2
Is a 401k withdrawal treated as "income" though? Any time I've filled out taxes in a software it has *special* sections for 401k withdrawals.
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#3
That $92,900 only applies to earned income.
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#4
Quote from Count_Chocula View Post :
That $92,900 only applies to earned income.
http://www.irs.gov/individuals/ar...08,00.html

Retirement savings are not indicated as either - but pensions are not considered earned income.
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#5
Quote from Count_Chocula View Post :
That $92,900 only applies to earned income.
The way I understand it, your 401k contributions are earned income - it's just that instead of paying the income tax as soon as you get your paycheck, you pay it decades later, when you withdraw your money plus whatever interest you made on it. I could be dead wrong on this one, but one's original 401k contributions don't seem to be either the interest/dividend or the pension...
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#6
So simple as in move somewhere far away. Even if that does work I wouldn't categorize it as simple.

That said, I did think of the same thing myself when I was considering moving to NZ but never figured out if it was legit or not... Big Grin

I also posed a question in here regarding a 401k loan. I am being told that I can borrow $50k and then repay it out of my paycheck before taxes. I have been told that numerous times by my company and the 401k administrator. WTH? Doesn't sound right. I can borrow $50k to use for whatever, hell even put in my savings account and it comes out of my paycheck tax free? Seems like a good way to get $50k tax free every year! May try it just to see what happens as I can't seem to find anyone that has actually done it and heard how it actually happened.
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#7
Quote from Night_Runner View Post :
The way I understand it, your 401k contributions are earned income - it's just that instead of paying the income tax as soon as you get your paycheck, you pay it decades later, when you withdraw your money plus whatever interest you made on it. I could be dead wrong on this one, but one's original 401k contributions don't seem to be either the interest/dividend or the pension...

I tell you what, you try it and if it doesn't work, I'll use the $5 SD exemption to buy you some soap-on-a-rope for your shared cell with Wesley Snipes.
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#8
Don't you still have to pay taxes in the country you are living in. That is how I remember it.
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#9
Quote from 808Lurker View Post :
Don't you still have to pay taxes in the country you are living in. That is how I remember it.
Yes, but some countries have lower taxes than others. nod If you want to take it to the extreme, I guess you can spend 11 months chilling in the international waters (=not under anybody's jurisdiction). I'm sure the IRS will appreciate your dedication to tax avoidance when you tell them you spent the year as a pirate. LMAO

Bummer about the 401k money not being treated as income, though. Oh well, I guess I'll always have the 72(t) rule [moneymanagment.info]...
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#10
Quote from LivninSC View Post :
I also posed a question in here regarding a 401k loan. I am being told that I can borrow $50k and then repay it out of my paycheck before taxes.
This is true, but it has to be for qualified expenses and has certain repayment period limitations. I took out a 15 yr $50K loan against mine as a payment for a new house. I think you can do a similar loan for home improvement but the term is only 5 years. I avoided a second mortgage and PMI as it allowed me to get below 80% LTV on my mortgage.

The loan is payed back automatically via paycheck withdraws but you have to pay it pack with interest (prime rate). The benefit is that I am paying the interest on the loan back to myself not someone else. Keep in mind the money in your 401K was added pretax and is payed back pretax so you are not bypassing the system by doing this.

You could potentially take out a bigger loan than needed and invest the additional in something but would you really gain that much over just investing the funds from within your 401K.
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#11
Tel US you live in argentina and tell argentina you live in US. No taxes! Also, try to die before the IRS catches you.
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#12
Quote from jensen18 View Post :
This is true, but it has to be for qualified expenses and has certain repayment period limitations. I took out a 15 yr $50K loan against mine as a payment for a new house. I think you can do a similar loan for home improvement but the term is only 5 years. I avoided a second mortgage and PMI as it allowed me to get below 80% LTV on my mortgage.

The loan is payed back automatically via paycheck withdraws but you have to pay it pack with interest (prime rate). The benefit is that I am paying the interest on the loan back to myself not someone else. Keep in mind the money in your 401K was added pretax and is payed back pretax so you are not bypassing the system by doing this.

You could potentially take out a bigger loan than needed and invest the additional in something but would you really gain that much over just investing the funds from within your 401K.
Seriously? That just seems like way too god of a deal. I understand the whole paying back with interest thing but it just seems like it's a great way to get $$ out w/o paying tax on it.

Say I wanted to put $100k down on a house and only had $50k in cash. I just borrow $50k and repay it int he first year. If I make $70k a year I basically take home $20k (before taxes but really there wouldn't be any as the amount is low) that year. Now let's say I didn't borrow that $$ and took my $70k salary. After taxes I'd probably take home $45k to $50k a year which is just enough to put aside for the $100k payment.

So basically if I borrow against my 401k I end up $20k ahead (assuming a ROR that is the same in my 401k more or less). Suhweeeeeeeeet!
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#13
On a side note I have also wondered if you could just take a couple years off and pull $$ out and not pay tax on it.

Say I want to take 2012 and 2013 off and travel the US, or kick back on the Hawaiian Islands. Could I just withdraw like $25k a year and pay virtually no taxes? I mean if you're gonna go to Argentina and presumably not work why not just stay in the US and do it that way.
Take $25k less the standard deduction of $12k and you're ending up having to pay $1,250???

Financially it doesn't make sense to take the time off just to pay less in taxes but if you're gonna do it anyways it seems like a decent way to get access to your 401k early and at a pretty damn low tax rate. Assuming you weren't going to work at all you may as well take advantage of the standard deduction at the very least, if something like that was to work!
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#14
you wouldn't have to be a pirate for 11 months, you can just spend a few months in different countries - say 4 months in Spain, then 4 in France, and then 3 in Germany - that way you still have 11 months outside the U.S., and you won't be paying taxes in S/F/G since you spend < 6 months in them (I think, I don't know the exact tax laws in those countries, but I would expect it to be so) (you might want countries that speak English, so maybe Australia and England? 5.5 months in each?)
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#15
Quote from LivninSC View Post :
Seriously? That just seems like way too god of a deal. I understand the whole paying back with interest thing but it just seems like it's a great way to get $$ out w/o paying tax on it.

Say I wanted to put $100k down on a house and only had $50k in cash. I just borrow $50k and repay it int he first year. If I make $70k a year I basically take home $20k (before taxes but really there wouldn't be any as the amount is low) that year. Now let's say I didn't borrow that $$ and took my $70k salary. After taxes I'd probably take home $45k to $50k a year which is just enough to put aside for the $100k payment.

So basically if I borrow against my 401k I end up $20k ahead (assuming a ROR that is the same in my 401k more or less). Suhweeeeeeeeet!
Don't get too excited, if this is true, everyone will be doing it already.

1. 401k loan payment is done with AFTER-TAX money, not BEFORE-TAX money, otherwise the loan you took out is not getting taxed.

2. You'll be double-taxed for the INTEREST (not principal), since you pay interest with your after-tax money, then it goes into 401k as pre-tax money. When you take out 401k, it'll be taxed again (interest portion).
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