Vacation Leave Payout or 457

[AlbaCrush]

I submitted all my retirement paperwork to HR yesterday and I have two months until I retire at age 50 with a $55,000 cola pension and 80% health care plan paid.

I've been saving my vacation leave and when I retire, I'll have 362 hours to sell back ($17,000). I have the option of receiving a lump sum payment which I was told would be taxed at 34% or roll it into my 457 plan tax deferred.

I only owe $15,000 on my home and I'd like to pay it off with the lump sum payment. I would have to add a few thousand after the taxes. I keep having people tell me I want a mortgage for tax purposes. I don't see the advantage because I'm not paying much in interest on such a small amount. Since, my pension is $55,000 (About $3,000 after taxes, health care), I like having it paid off.

I'd appreciate input from others on taking the lump sum vs 457 plan.

Thanks

 

[Another Reader]

The 34% tax hit is egregious. In your shoes, I would roll it over. Pay the mortgage off out of your cash flow, or if possible, take small distributions from the 457 at a lower tax rate to pay off the mortgage.

 

[healthyandfun]

I had a similar situation with about $30,000 of sick leave compensation. I knew I could have stashed a large chunk tax-deferred in my 403b. I weighed all the pros and cons. I decided to bite the bullet, pay the income taxes, and use it to beef up my emergency fund. It certainly has given me peace of mind. I also received a big income tax refund because my pension was lower than my paycheck. My suggestion would be to look at your entire financial picture and then make your decision.

 

[Philliefan33]

Would the lump sum be taxed at 34%, or will they withhold 34%? There's a difference, and it might affect your decision.

 

[Senator]

Would the lump sum be taxed at 34%, or will they withhold 34%? There's a difference, and it might affect your decision.

There is a big difference, he may owe even more. I know if I received that much, I would be hit with a 28% federal income tax, and a 7%+ state income tax. Mcare would add another 1.45%. If I had not maxed FICA out, add another 6.2% tax.

A total of 42%+ in taxes on those last dollars. Another reason I am leaving my W2 job in 10 days...

 

[Just_Steve]

I had almost 800 hours between sick time and vacation time, even though I retired in December they didn't process my lump sum until February, so I maxed my 457 and did one year catch up then the rest I opened a 401k and stashed it there. If I had taken it in cash the amount of taxes paid would have been unbelievable. No way was Uncle Sam getting that. So now I take small distributions to supplement the pension and pay way less taxes. And to add to Senator's post above, they did take SS and Medicare out of the lump sum. The rest was deferred.

 

[cathy63]

Vacation payout should be treated as ordinary wage income on your W-2, so even though they withhold at the higher supplemental rate now, you'll get back any excess when you file your tax returns next year and it may prevent you from having to pay estimated taxes for the rest of this year.

Whether it's beneficial to have a mortgage or not depends on whether you can itemize your deductions. You might want to try doing two tax returns for 2016, one with the lump sum and the mortgage pay-off; one with the vacation pay deferred and the mortgage interest continuing until the end of the year. Then you'll have some actual numbers to look at and can see which option benefits you most.

 

[cathy63]

There is a big difference, he may owe even more. I know if I received that much, I would be hit with a 28% federal income tax, and a 7%+ state income tax. Mcare would add another 1.45%. If I had not maxed FICA out, add another 6.2% tax.

A total of 42%+ in taxes on those last dollars. Another reason I am leaving my W2 job in 10 days...

Yep, the $10K bonus I got last month turned out to be $5622 when it was deposited in my checking account -- so 43.78% tax. That's the supplemental withholding rate for both state and Fed, which is higher than my marginal tax rate, so some will come back in refunds, but I sure don't like lending it to the government for 7 months!

Four more work days as a full-timer, then 3 months of occasional part-time work and I'm done! My endless summer starts next Friday.

 

[Senator]

Yep, the $10K bonus I got last month turned out to be $5622 when it was deposited in my checking account -- so 43.78% tax. That's the supplemental withholding rate for both state and Fed, which is higher than my marginal tax rate, so some will come back in refunds, but I sure don't like lending it to the government for 7 months!

Four more work days as a full-timer, then 3 months of occasional part-time work and I'm done! My endless summer starts next Friday.

The federal supplemental tax rate is only 25%, you may still owe if you are in the 28% bracket for last dollars earned... Unless they treated the income as if you were getting that amount every pay period.

have a great summer. Mine starts on 7/5/16, 10 days.

 

[gayl]

Please talk to your HR regarding payout. They can bump your deductions WAY up on that last paycheck so that you get most of it (less HC, FICA, Medicare). FWIW: I had my sick leave added to length of service + vacation / mgmt leave put into the final paycheck as my mortgage was paid off the month b4 I retired and I needed to pay the pension board a boatload to cover unfunded liability (67k total -- Paid most over 3 yrs but then large check at end = 5 yrs break even pt)

 

[DrRoy]

I would roll it and save the taxes. Raise the cash from a different source without the tax hit.

 

[AlbaCrush]

Would the lump sum be taxed at 34%, or will they withhold 34%? There's a difference, and it might affect your decision.

It would be taxed at that rate. I'm not sure if that included State tax. If it didn't that would be additional 4.75%.

After reading the posts on here, I think the best option would be the 457 plan to avoid the high taxes on the lump sum. It also could earn money in the plan. No intentions of taking any distributions at this time.

I have $43,000 in a savings account that is for emergencies. I really don't want to touch that right now, so I'll try to just pay the mortgage payments until it's paid off in June 2018.