Is TurboTax calculating tax on social security benefits + early 401K withdrawal correctly?

[joannabanana6]

We are married, filing jointly, no dependents.  My husband is 67 and I am 64. I'm trying to get an estimate of what our 2023 return will look like (realizing taxes will be changing). I have three questions:

1.  Our only income right now for 2023 will be social security benefits of $63,923 (combined).  This calculates out to $0 tax owed.  I'm assuming that is correct?

2.  However, my husband wants to withdraw approximately $30K from his 401K account (over the course of the year) to supplement our income. TurboTax calculated that (based on 2022 numbers) that we would owe $5466 if we do that!  ($3,000 of that is the 10% penalty).  Does that amount sound right?

3.  I'm trying to convince him that it makes MUCH more sense to take the funds out of our savings instead of the 401K, but he states that he wants to hold onto the cash in the savings and not use that until we absolutely have to. In my opinion, it should be the other way around!  How do I convince him of this?

Thanks for any input!  🙂

[xmasbaby0]

What 10% penalty?   There is no 10% early withdrawal penalty if he is older than 59 1/2.    You say he is in his 60's.    You would owe tax on the distribution, but there would not be a penalty.  

[dmertz · Accepted solution]

I suspect that you've used the wrong code for the Form 1099-R.  The Form 1099-R for the $30,000 of distributions from the 401(k) will have code 7, not code 1.  Using code 1 will result in a 10% early-distribution penalty that should not be present.

Because your combined Social Security benefits are very close to $64,000, your Adjusted Gross Income increases by $1.85 for almost every $1 of income from the 401(k).  The result is that your taxable income is somewhere near $24,000 which is taxed at 10%.

If the money from the 401(k) is not immediately needed for spending, it would be FAR better to do Roth conversions each year of amounts that keep you just below the threshold where your taxable income becomes nonzero.  (I would expect that for 2023 that would be somewhere around $17,000 in Roth conversions, but you can wait until the near the end of 2023 to complete the Roth conversions for 2023.)  Over age 59½, amounts up to the total amount converted can be taken out of the Roth IRA at any time, free of tax and penalty.  Once it has been at least 5 years since the beginning of the year for which the first Roth contribution or conversion was made, earnings will also be free of tax and penalty.  Spend the ordinary savings first and then take other money from the Roth IRA as needed after the ordinary savings are depleted.  There is no point in having any portion of the 401(k) income taxed at a marginal tax rate of 18.5% unless you anticipate having a higher marginal tax rate in the future.  Also consider state income taxes, if any.