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Strategy on separation from service at age 55
Old 04-18-2012, 01:42 PM   #1
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Strategy on separation from service at age 55

Ok, so I know that if you separate service from an employer at age 55, you can take your 401k and run without the usual 10% penalty...but I do have some clarifying questions.

This relates to my DW, who will be 55 on Feb 6th, 2013 and may leave the company during 2013.

Let's assume for the sake of argument that she makes $100,000/year. Further assume she has two plans at work. One is a 401k plan, which has a combination of:
After-tax employee contrib - $20k
Pre-tax employee contrib - $50k
Employer contrib to pre-tax - $12k
Growth - $28k
Total 401k = $110k

She also has a cash balance plan. This is a defined contribution plan whereby employer puts 6% of pay into a trust account, employer adds nothing, and it grows. Let's assume this has $130k.

So now my questions are:
1) Does the ability to withdraw the money apply to both the 401k and the cash balance account after 55 upon separation?
2) Is this one of those things where the law permits it, but I have to check with employer to see if they allow? Or is the law clear that they MUST allow it?
3) Is the timing of her separation important? For example, let's assume for simplicity she is single. If she works only 2 months in 2013, then separates, the pre-tax portion would go against regular income...but since her annual income is so low due to separating early in the year...her marginal tax rate would still be quite low. However, if she instead separated on 12/15/13, her income would be nearly $100k from wages, PLUS $90k of pre-tax from the 401k, thus triggering a huge tax bill. Would it therefore be smarter to wait in the latter situation until January of 2014 to take the distribution? Is she allowed to wait over the end of a year like that?
4) I would imagine the cash balance money would be treated as pre-tax given that no taxes have been paid on this...do you agree?

Any other considerations I should be aware of?

I'm only 50...so this likely will not be an option for me. I'm still working and earning over 6-figures...so we may not do this regardless...I'm just trying to understand all the options at this point.

THanks for all your views in advance.

Dave
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Old 04-18-2012, 02:01 PM   #2
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When DW left her company at age 49, her cash balance pension money was rolled into her 401k. She then rolled her 401k into an IRA and there were no penalties involved and taxes to be paid.

If your DW wants to take the money and start to spend it she could do something similar then start withdrawing from the IRA. The after tax money should be identified in the rollover and form the cost basis of the rollover IRA.
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Old 04-18-2012, 02:07 PM   #3
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I believe the cash balance plan is a defined benefit plan. Have you looked through the SPD?

I believe distributions from a 401k after the age of 55 are not on a fixed schedule, as they are distributions with the 10% penalty waived. In other words, timing of the separation shouldn't be important. In your example, if your spouse worked until Dec, she wouldn't have to take a distribution of any set amount if she didn't want to. My understanding is she could retire 2/7/13 and not take a distribution until 1/1/14 if she didn't want.
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Old 04-18-2012, 02:12 PM   #4
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Originally Posted by Alan View Post
When DW left her company at age 49, her cash balance pension money was rolled into her 401k. She then rolled her 401k into an IRA and there were no penalties involved and taxes to paid.

If your DW wants to take the money and start to spend it she could do something similar then start withdrawing from the IRA. The after tax money should be identified in the rollover and form the cost basis of the rollover IRA.
the 401k plan would have to allow this rollover. Also, if you roll into an IRA, the age 55 penalty exclusion is gone. And yes, you should be able to take non-qualified distributions of after-tax contributions.

EDIT: By after-tax contributions, I meant Roth. After-tax can also mean when you contribute over the limit - and I don't believe you can withdraw those early without penalty via an IRA.

it's very difficult to make specific recommendations without the entire picture.
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Old 04-18-2012, 02:12 PM   #5
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Quote:
Originally Posted by Alan View Post
When DW left her company at age 49, her cash balance pension money was rolled into her 401k. She then rolled her 401k into an IRA and there were no penalties involved and taxes to be paid.

If your DW wants to take the money and start to spend it she could do something similar then start withdrawing from the IRA. The after tax money should be identified in the rollover and form the cost basis of the rollover IRA.
According to this article, you cannot put the money in an IRA. Not sure how your DW did hers based on the prior article I read.

Fool.com: Escape the Early Withdrawal Penalty [Retiree Portfolios] November 26, 2001
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Old 04-18-2012, 02:22 PM   #6
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Originally Posted by ronocnikral View Post
I believe the cash balance plan is a defined benefit plan. Have you looked through the SPD?

I believe distributions from a 401k after the age of 55 are not on a fixed schedule, as they are distributions with the 10% penalty waived. In other words, timing of the separation shouldn't be important. In your example, if your spouse worked until Dec, she wouldn't have to take a distribution of any set amount if she didn't want to. My understanding is she could retire 2/7/13 and not take a distribution until 1/1/14 if she didn't want.
I'm staring at it right now...how do I find this? I don't see any language saying "This is a defined benefit plan".

Edit: Just found this...you are right
Type of Plan
Tax-qualified defined benefit plan.

SO why is whether it's a DC or DB relevant? It is tax-qualified.
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Old 04-18-2012, 02:24 PM   #7
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Just found this in the link I posted below...answers my question #2.

"The plan does not have to permit such withdrawals. The plan documents will dictate how and when distributions may be made. "
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Old 04-18-2012, 02:27 PM   #8
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Originally Posted by Finance Dave View Post
I'm staring at it right now...how do I find this? I don't see any language saying "This is a defined benefit plan".
I don't know if it will say "This is a defined benefit plan." One hint will be if it calculates out lump sump payments or annuity payments based on age.
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Old 04-18-2012, 02:31 PM   #9
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According to this article, you cannot put the money in an IRA. Not sure how your DW did hers based on the prior article I read.

Fool.com: Escape the Early Withdrawal Penalty [Retiree Portfolios] November 26, 2001
I don't see where it says you can't transfer the money from a 401k or other tax advantaged account into an IRA penalty free. ( a withdrawal is not the same as a rollover)

When DW did it was easy peasy. She called Fidelity and told them what she wanted to do. The agent called up her employer's plan administrator (TRP), and they had a 3-way conversation. Her 401k plan allowed rollovers, and it was all handled in that one phone call.

A few years later I did something similar except that my employer's plan did not allow electronic transfers so I had to do it all by mail, including a physical check that I had to forward onto my IRA provider (Vanguard in my case)
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Old 04-18-2012, 02:33 PM   #10
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Originally Posted by ronocnikral View Post
I don't know if it will say "This is a defined benefit plan." One hint will be if it calculates out lump sump payments or annuity payments based on age.
See my prior post...I edited it...found it.
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Old 04-18-2012, 02:34 PM   #11
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I don't see where it says you can't transfer the money from a 401k or other tax advantaged account into an IRA penalty free. ( a withdrawal is not the same as a rollover)

When DW did it was easy peasy. She called Fidelity and told them what she wanted to do. The agent called up her employer's plan administrator (TRP), and they had a 3-way conversation. Her 401k plan allowed rollovers, and it was all handled in that one phone call.

A few years later I did something similar except that my employer's plan did not allow electronic transfers so I had to do it all by mail, including a physical check that I had to forward onto my IRA provider (Vanguard in my case)
Am I reading it wrong? Here's the quote:

To make a penalty-free withdrawal, the money must remain in and come from your employer's plan. If the money is transferred to a traditional IRA, the age 55 exception no longer applies.
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Old 04-18-2012, 02:40 PM   #12
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Originally Posted by ronocnikral View Post
I believe the cash balance plan is a defined benefit plan. Have you looked through the SPD?

I believe distributions from a 401k after the age of 55 are not on a fixed schedule, as they are distributions with the 10% penalty waived. In other words, timing of the separation shouldn't be important. In your example, if your spouse worked until Dec, she wouldn't have to take a distribution of any set amount if she didn't want to. My understanding is she could retire 2/7/13 and not take a distribution until 1/1/14 if she didn't want.
ok, that's good to know. I can confirm this when I call them.
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Old 04-18-2012, 02:44 PM   #13
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Even before age 59 1/2, you can withdraw from an IRA penalty free through Rule 72t.

"The IRS permits early retirees to access their retirement funds prior to age 59 1/2 without penalty as long as they take distributions under a plan of substantially equally periodic payments (rule 72t). Once started, these payments must continue for the longer of 5 years of their attainment of age 59 1/2. Therefore, once a 72t distribution plan is started, these become required mandatory distributions subject to the early withdrawal penalty if ceased.
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Old 04-18-2012, 02:44 PM   #14
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Are you guys talking apples and oranges here?

Finance Dave sounds like he is describing a scenario where you can withdraw your 401K balance at 55 and spend it. I don't know anything about this.

Alan sounds like he is talking about a 401K rollover into an IRA. This is common and I have done it personally. If you do a direct rollover correctly then you don't pay a 10% penalty. There are several disadvantages to this that I've since learned. 1) If you previously would not of had a traditional (pre tax) funded IRA and this creates one then it will cause problems if you were using the backdoor roth conversion to work around income limits. 2) 401K plans have greater protection against creditors than IRA plans 3) I'm sure there are other key differences.
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Old 04-18-2012, 02:45 PM   #15
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Am I reading it wrong? Here's the quote:

To make a penalty-free withdrawal, the money must remain in and come from your employer's plan. If the money is transferred to a traditional IRA, the age 55 exception no longer applies.
It is talking about a withdrawal, which is not the same as a rollover.

A withdrawal means the money goes into your wife's bank account for her to spend as she wishes.

A rollover means it goes to her IRA account which is subject to the IRA withdrawal rules in that it will be subject to a 10% penalty if she makes withdrawals before she is 59.5, unless she sets up SEPP payments. Unless you and/or your wife need to spend some of the 401k money before she is 59.5 then I would keep it in the IRA or 401k.
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Old 04-18-2012, 03:01 PM   #16
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..........So now my questions are:
1) Does the ability to withdraw the money apply to both the 401k and the cash balance account after 55 upon separation?
2) Is this one of those things where the law permits it, but I have to check with employer to see if they allow? Or is the law clear that they MUST allow it?
3) Is the timing of her separation important? For example, let's assume for simplicity she is single. If she works only 2 months in 2013, then separates, the pre-tax portion would go against regular income...but since her annual income is so low due to separating early in the year...her marginal tax rate would still be quite low. However, if she instead separated on 12/15/13, her income would be nearly $100k from wages, PLUS $90k of pre-tax from the 401k, thus triggering a huge tax bill. Would it therefore be smarter to wait in the latter situation until January of 2014 to take the distribution? Is she allowed to wait over the end of a year like that?
4) I would imagine the cash balance money would be treated as pre-tax given that no taxes have been paid on this...do you agree?.............
Based on my recent experience with my former employer's plans.

1. Penalty-free withdrawals before age 59 1/2 are only available from the 401k if the employee is 55 or older when they leave the employer. If you plan to tap those funds between when your DW is 55 and 59 1/2 then you should leave the funds in the 401k (don't roll the 401k over into an IRA).

2. I don't believe that she can receive penalty-free distributions from the cash balance plan, only the 401k. She can however, roll the cash balance plan into an IRA is she wishes to. I did because my IRA offered better investment choices than my cash balance plan.

3. I agree with your observations. I ended work in December and went on vacation from then until February and collected my unused vacation but increased my 401k contributions to 100% so I had no W-2 earnings in 2013. The added benefit was that I was able to continue on my employer subsidized health plan for and additional 2 months (Jan and Feb).

4. Yes, any withdrawals from the cash balance plan would be taxable when withdrawn and subject to penalty if withdrawn before 59 1/2.

YMMV
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Old 04-18-2012, 03:31 PM   #17
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It is talking about a withdrawal, which is not the same as a rollover.

A withdrawal means the money goes into your wife's bank account for her to spend as she wishes.

A rollover means it goes to her IRA account which is subject to the IRA withdrawal rules in that it will be subject to a 10% penalty if she makes withdrawals before she is 59.5, unless she sets up SEPP payments. Unless you and/or your wife need to spend some of the 401k money before she is 59.5 then I would keep it in the IRA or 401k.
Yes, but that's what the whole point of this thread is...withdrawals. You'll note in my original post I used the word withdrawal.
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Old 04-18-2012, 03:38 PM   #18
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Based on my recent experience with my former employer's plans.

1. Penalty-free withdrawals before age 59 1/2 are only available from the 401k if the employee is 55 or older when they leave the employer. If you plan to tap those funds between when your DW is 55 and 59 1/2 then you should leave the funds in the 401k (don't roll the 401k over into an IRA).

2. I don't believe that she can receive penalty-free distributions from the cash balance plan, only the 401k. She can however, roll the cash balance plan into an IRA is she wishes to. I did because my IRA offered better investment choices than my cash balance plan.

3. I agree with your observations. I ended work in December and went on vacation from then until February and collected my unused vacation but increased my 401k contributions to 100% so I had no W-2 earnings in 2013. The added benefit was that I was able to continue on my employer subsidized health plan for and additional 2 months (Jan and Feb).

4. Yes, any withdrawals from the cash balance plan would be taxable when withdrawn and subject to penalty if withdrawn before 59 1/2.

YMMV
Thanks...I'm slowly coming to an understanding of the best option for us.

And the more I think about the cash balance plan...it's really more like a pension plan, and I believe we have two options upon separation....1) Annuity 2) lump sum. I'd probably do the lump sum and put it in an IRA...just not sure whether I'd do a TIRA or a Roth. If a TIRA, it would have to be a non-deductible due to our HCE status. Alternatively, if we use the "wait until the year she has no income" strategy, we may just put it in a bank and use it as our spending money...it all depends on whether I keep w*rking or not. Lots of options floating around in my head for the next 12-24 months.
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Old 04-18-2012, 03:50 PM   #19
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Yes, but that's what the whole point of this thread is...withdrawals. You'll note in my original post I used the word withdrawal.

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According to this article, you cannot put the money in an IRA. Not sure how your DW did hers based on the prior article I read.

Fool.com: Escape the Early Withdrawal Penalty [Retiree Portfolios] November 26, 2001
We must have been talking cross-purposes. My initial response to you was that DW rolled her 401k to an IRA rather than making withdrawals and you responded that should not have been possible.

No worries, we are all on the same page now.
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Old 04-18-2012, 04:30 PM   #20
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Thanks...I'm slowly coming to an understanding of the best option for us.

And the more I think about the cash balance plan...it's really more like a pension plan, and I believe we have two options upon separation....1) Annuity 2) lump sum. I'd probably do the lump sum and put it in an IRA...just not sure whether I'd do a TIRA or a Roth. If a TIRA, it would have to be a non-deductible due to our HCE status. Alternatively, if we use the "wait until the year she has no income" strategy, we may just put it in a bank and use it as our spending money...it all depends on whether I keep w*rking or not. Lots of options floating around in my head for the next 12-24 months.
You may want to check out the options. I had two cash balance type plans, one of which I could roll the balance into my tIRA or I could take an annuity. I got a quote on an annuity from the plan and it was much more than if I rolled the lump sum into a tIRA and then bought an immediate annuity. So I left that plan as is and will annuitize it later.

Unless you enjoy writing big checks to Uncle Sam, your rollover would be to a tIRA and then you can convert monies from the tIRA to a Roth as desired.
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