Distirbution's from 401k Plan; For Debt

[garryweld]

Hi ERF,
I am Garryweld and I would like know if anyone can help with a decision I have got make ? SITUATION: I just recently RETIRED with 33 yrs. in a Steel Mill an feel like I was forced to do so, do to a recent LOCKOUT by Company. The decision is should I pay off all debt = $133,000.00. The payoff would be with a 401k distribution from a total of $215,000.00 roll the rest over into an IRA if taxes don't eat it up. I am 55yrs. old at retirement. There is a 20 percent tax off the top and a exception rule for being 55 & retired. As it is at the present time my bills are to high for me to make with just my Pension Check of $1876.50.

Thank You
Garryweld

 

[JohnP]

Hi Garry!

Welcome to this board - I'm sorry to hear about your lockout-caused unplanned retirement.  Your pension and 401k distribution should provide a basis for the rest of your life. 

Before I'd take the $133,000 out of your 401k, I'd first check the components of the debt to see if there is some that you could defer.  The problem is that taking $133k out of the 401k in one lump will give you a pretty big one-year fed (and state) income tax hit.  If you have high cost credit card debt, by all means pay them off right away, but consider retiring your debt with an eye open to the tax consequences! 

Your pension along with prudent withdrawals from your IRA, 401k and any other retirement funds should provide a good basis for your new-found freedom.  Welcome to the rest of your life

Best Regards

JohnP

 

[Martha]

What kind of debt is this? Home mortgage? Car loans?

What do your monthly expenses end up at with and without the debt? Any source of income besides the pension?

As John says, if you pay the debt all at once, you will have a big one year tax hit. Maybe based upon the type of debt, interest rates, and the like, you can make a plan to stretch out the payoff over time to save taxes.

If you left the money in your 401k or rollover IRA, you should be able to take out about $8600 a year indefinitely (based upon taking out 4% a year), before taxes.
That plus your pension gives you $2592 a month.

 

[renferme]

Hi Garry,
If you pay off $133,000, it means that you'll have to take out about $166,000.
20%, or $33,000, will be withheld for FIT. That doesn't leave much to rollover.
.
Could you leave the money in the 401k, but take out a certain amount each month,
say $1000 for example (more or less), to help pay your debts ? My 401k allows me to do that.
If you rollover everything into an IRA, you cannot take any money out until you reach 59.5. Exception is a 72t withdrawal, which, IMHO, is a pain in the butt.
.
If you take $1000 per month, you can tell the 401k people how much you want withheld (that's what I did).

 

[TromboneAl]

Bennevis, why is the 72t withdrawal a pain in the butt?

 

[cute fuzzy bunny]

Mostly because you have to do it, and do it exactly every year for the rest of your life. And doesnt your beneficiary have to continue that even after your life ends?

 

[SteveR]

Mostly because you have to do it, and do it exactly every year for the rest of your life.  And doesnt your beneficiary have to continue that even after your life ends?

72t for this guy would be 5 years of payments under the 72T rules. After that, he can stop or take whatever he wants up to age 70.5 when RMDs would take affect.

 

[cute fuzzy bunny]

Ya learn something new every day. I didnt know you could stop and didnt see anything to that effect when I looked into it. All I saw is that you could change the way you calculated the withdrawal amounts after 5 years.

 

[garryweld]

Re: The Debt

Most of the debt is the Mortgage on my Home which is around $ 89,500.00, the rest is credit "ugh"cards "YUCK" !!!
If I drew out $ 166,000.00, pius my Pension $2206.50 a month which I have 15% taken out. Then 20% from the distribution that would leave $132,800.00, plus special pension payment of $14,735.00 which 20% come's off of that for taxe's, leaving $11,788.00. So if I total all figures to gross yearly income "ughhhhhh" that come's out to be
$196,180.50. What would be my tax burden for 2006. As I don't know how to figure in the tax'es that I've already PAID. Sorry I just don't understand, an I would like to, but this all came to sudden, so I'm thinking the debt burden would be a relief at this point. Thank You in advance for your time & knowledge.

Garryweld

 

[nuisance]

Paying off the debt by taking a large 401k withdrawal might be the way to go, but I would try really hard not to go that route.
First, you might be able to add some money back to your mortgage. See what the bank will let you.
Second, you might be able to borrow money from your 401k account. Not all plans allow this, and there are limits, but that avoids the tax penalty.
Then set up 72(t) withdrawals so you can repay the money you borrowed in the time allowed.
If that's not enough, then you may have to take an early withdrawal, or maybe it's manageable at that point.
Finally, tear up your credit cards. Different things work for different people, and it sounds like credit doesn't work for you.
I'm sure others have other ideas. How much money do you need each month? It might be time to tighten your belt for a few years to get this debt under control.

Tim

 

[setab]

garryweld,

My situation is similar to yours and I have given considerable thought to cashing out and paying off the bulk of my debt. For the time being, at least, I have decided against that course of action. First, the tax bite would be obscene, as in the 33 percent bracket. Second, I like the security of having the TSP there for the future. I would truly love to be totally debt free and am finally working that way, but I didn't get here over night and I won't out of here over night either, but at least I'm headed in the right direction and have got my spending head on a lot straighter. I will only cash out if I absolutely have to.

setab

 

[Martha]

Re: The Debt

Most of the debt is the Mortgage on my Home which is around $ 89,500.00, the rest is credit "ugh"cards "YUCK" !!!
If I drew out $ 166,000.00, pius my Pension $2206.50 a month which I have 15% taken out. Then 20% from the distribution that would leave $132,800.00, plus special pension payment of $14,735.00 which 20% come's off of that for taxe's, leaving $11,788.00. So if I total all figures to gross yearly income "ughhhhhh" that come's out to be
$196,180.50. What would be my tax burden for 2006. As I don't know how to figure in the tax'es that I've already PAID. Sorry I just don't understand, an I would like to, but this all came to sudden, so I'm thinking the debt burden would be a relief at this point. Thank You in advance for your time & knowledge.

Garryweld

Here is a very rough calculator to figure your potential federal taxes: http://www.dinkytown.net/java/Tax1040.html

Have you put together a budget? I would be inclined to payoff the credit card debt and keep the mortgage for now. Otherwise, you are going to lose a lot to taxes that you really shouldn't have to lose.

 

[Intuit]

Garryweld, have you conssidered taking a loan from your 401K? I'm not sure if that is an option now that you are retired but it avoids the tax liability and basically you are borrowing from yourself. You still loose the earning power of the money in your investments but you pay yourself normally about 5% interest back. Just another idea. Good luck.

 

[Martha]

Garryweld, you mentioned the 20% taken off the top when you move the money out of the 401k. This doesn't have to happen. If you do a direct rollover into an IRA, no taxes have to be withheld. Also, because you have more than $5000 in the 401k you do have the option of leaving the money in the 401k. Unless your company terminates the 401k plan. But we don't know if your 401k plan allows partial distributions. Do you know what your 401k plan lets you do once you retire? You should read your summary plan description.

A 401k loan, if allowed by your plan, can occur after you retire. However, it is a loan and will need to be paid back or suffer the tax consequence of default.

Another possibility is to see if you can take a partial distribution from your 401k, enough to pay the high interest credit card debt and taxes from the distribution. If the plan allows you to take partial distributions, you could continue in the future to take distributions as needed to pay your expenses. But you will have to find out what your 401k plan allows.

If partial distributions are not allowed, then you could rollover into an IRA and do 72t distributions for at least five years. your IRA provider might be able to help you with the 72t distributions.

So, to make a decision, it is important to know what your budget is so you know how much debt you can service. It is also important to know what your 401k plan will allow you to do with respect to distributions. Tax effects can be estimated with the Dinkytown calculator I linked to above.

 

[renferme]

72t is a pain in the butt, mostly, because you have to do it for 5 years or until you turn 59.5, whichever comes last.
And, should you run out of money before that time, you are subject to the 10% early withdrawal penalty!
So, you have to be real careful how much you withdraw. If you're heavily into equities and the market does what it did 2000 - 2002, you could be in trouble.

 

[renferme]

You have an $89500 mortgage and $43500 in other debts.
You could take out half of the 43,500 (not including the FIT) in 2006 and pay off
half the other debts (that would be about a 27,200 withdrawal to include FIT withholding).
Then in January 2007, take the other half 27,200 and pay off the remaining other debt (probably less because you would have made payments thru end of 2006.
Now, in Jan 2007, all you have left is the mortgage, which will be something less than $89500 because you've made mortgage payments all of 2006.
This way, you can figure it out yourself, you're Fed. tax burden is spread over 2 years. Maybe that helps.
Don't know what your mortgage interest is, but maybe you could refinance, get a lower rate, and lower your monthly payments; that may or may not be a good idea, as I don't think you would want to go to a 30 year loan as a replacement for what you have now. Only you know about that.
.
I'm updating this thread because I realized that if your plan is like mine, you can
either withdraw everything and move to an IRA, or you can get monthly equal payments out of your plan - you most likely, cannot make one withdrawal now and another next year. So, reluctantly, my idea above is probably not viable.
Sorry.

 

[cute fuzzy bunny]

whichever comes last.

Ah, thats where I got screwed up...I knew it was about 15 years for me, but its ~5 for the OP. I knew *I* couldnt stop in 5 years.

 

[justin]

And, should you run out of money before that time, you are subject to the 10% early withdrawal penalty!
So, you have to be real careful how much you withdraw. If you're heavily into equities and the market does what it did 2000 - 2002, you could be in trouble.

There is an exception to the 10% penalty that says when the account balance hits zero, you aren't penalized for withdrawing zero each year.

IRS ruling 2002-62 allows plans that run out of funds to NOT incurr the 10% penalty tax. Rev. Ruling 2002-62, 2.03(a) states... "If, as a result of following an acceptable method of determining substantially equal periodic payments, an individual's assets in an individual account plan or an IRA are exhausted, the individual will not be subject to additional income tax under 72(t)(1) as a result of not receiving substantially equal periodic payments and the resulting cessation of payments will not be treated as a modification of the series of payments."

In other words, you can try to front-end load your withdrawals, and if you run out of money in your IRA, it won't matter tax penalty-wise.

 

[renferme]

that's good to know !

 

[justin]

that's good to know !

The 72t is fairly flexible if you plan ahead before you use it. You can even split your IRA into multiple IRA's, then 72t each one of them at different points if you want to increase your income stream in the future, or if one of the sub-IRA's gets depleted. The paperwork and following the exact distribution amounts is the tricky part.

 

[ShokWaveRider]

GarryWeld:

If it were me, I would take out the cash from the 401k using the 72T option and pay the majority of it into the CC Debt. Then pay the mortgage off as normal. This will offset the taxes on both the 72T and your pension. Not perfect, but it does save the 20%.

Your approx 72T distribution for 5 years would be around $13,811 per year which would be about 1150 per month. I made some guesses when I did the math but it should be close.

Otherwise, I would take out only enough to pay the CC debt and keep the mortgage, maybe refi to get the payments managable.

SWR