401K cash out?

[Guest skv7]

My husband's plant closed and we would like to use the money in his 401k to pay off our house. He can withdraw the money with a 10% penalty since he will no longer be working for them. My question is... can he withdraw some this year and some next? Or is the withdrawal a one time deal. I want it to hurt the least at tax time. We would end up paying $30,000 in interest on the house so if I keep the penalty around that I'm happy. We need $71,000 to pay it off.

[Mike Preston]

It depends on the plan itself. That is, there is no provision of ERISA or the Internal Revenue Code which would require that the plan allow your husband to take a partial distribution this year and the balance next year. Conversely, there is nothing that requires the plan to require a one-time distribution only. You are therefore "stuck" with whatever the plan says.

I think you may have your numbers a bit skewed. If all you need to pay off the house is $71,000 and you are paying upwards of $30,000 interest over two years, your interest rate is approaching, if not higher than, 20% per annum. Are you sure your interest rate is that high?

How old is your husband? If over a certain age (maybe somebody else can look it up for you), the 10% penalty doesn't apply. This is kind of critical, because one suggestion I'm sure you will hear will be to take a complete distribution and roll it to an IRA. Then, your husband can withdraw the monies you want in year one and the balance in year two, thereby thwarting the plan if its provisions do require a single distribution. However, if you go down this path there is no exemption from the 10% penalty available (even it if would have been available had he taken a distribution directly from the plan).

As you can see, these things can get complicated. Your best bet is to sit down with somebody who can help you navigate this decision; somebody who is familiar with the tax rules and who you can feel comfortable giving them the personal information they request of you.

Good luck.

[Guest skv7]

I'm sorry, I meant if we keep the loan for the 13 years we have left then we would be paying 30,000. My husband is only 44. Jobs are hard to find in our area and we want to be sure we don't lose the house.

[Mike Preston]

With him being only 44, you are looking at the extra 10% tax for any distributions you take. I am going to again make the comment that you need to sit down with somebody who can help you plan on a long term basis. For example, you may want to consider rolling the entire $115,000 over to an IRA and then taking money out of the IRA only if you absolutely need it. In this way, if your husband ends up finding and keeping a good job in a year or two, you will only have incurred the penalty on a small portion of the funds and the remaining funds can grow on a tax deferred basis. Nobody can tell you what the best course of action is unless they know many more personal details about you than *I* would feel comfortable asking about on a public forum!

Good luck.

[Guest mjb]

You need to discuss all options with a financial planner or tax advisor including electing a 72(t) distribution. In a 72(t) distribution your husband makes a direct rollover of the lump sum distribution to an IRA to avoid the 20% witholding tax. He then elects to receive a periodic payment approximating the mortgage payment from the IRA each month/year. There are three ways to calculate a 72(t) distribution. The amount remaining in the IRA grows tax free and the taxation incurred on the IRA payments are reduced by the interest paid on the mortgage. Best of all the 72(t) payments are not subject to the 10% tax penalty. The downside is that 72t payments must continue until your husband reaches age 59 1/2.

[Bird]

I agree that you need to sit down with someone to review all of your options. Something to think about is taking all of the money from the plan and rolling it to an IRA, then taking it as needed for living expenses, including your mortgage payments. It would probably be a particularly bad idea to take a giant lump sum in one year just for the sake of paying off your mortgage; not only will you have the 10% penalty but ordinary income taxes as well, and you might very well push yourself into a higher tax bracket.

If things get really bad and your husband can't find another job, and you bleed out small amounts next year, at least you won't be taking it out in a high tax bracket. And if things turn around and he gets a job, you won't have p*ssed away a ton of money in taxes and penalties.

A 72(t) systematic distribution is a possibility but you have to commit to a long, regular payout. It's worth thinking about.