Cashing out our 401K

[marjo1950]

I have a question about cashing out some of our 401K money to help us through a rough time as we won't be able to pay our bills in 2011 if we don't. I know there are penalites and tax liablities but we may have to swallow that painful "pill". We have around 23,000 in it and are thinking about getting at least half of it (if not ALL of it) out. Approxiamtely how much would we pocket (after penalities and taxes) if we got out 12,000? How much, if we got out the whole $23,000? If we were to roll it over to a traditional Roth IRA (I read about this in some of the postings) would we still be able to cash it out? The reason for our money setback is that my husband's employer stopped contributing, what they had been, on his health insurance benefits and, in order to keep the coverage, we are getting $350 less a month in his paycheck. This news came to us "all of a sudden..without more than a couple weeks warning. I have some physical problems that deemed it "very" important to keep health coverage through the employer so we had to chose to keep the coverage and get less pay each month.

Just want some insight on how much we "might" get after taxes and penalities. I know most of you will say DON'T DO IT but we've explored other avenues and this seems our only "hope"

Thanks!

[jpg7n16]

Hey Marjo,

From what I'm able to find online, you cannot bypass the 10% penalty by converting to a Roth, because the converted money will be subject to a 5 year rule. See quote below.

May I also ask why you need so much money withdrawn? That seems like much more than you would likely need right now.

Depending on your other income for the year, any withdrawal will taxed at your highest marginal rate plus a 10% penalty. So assuming you were in 25% bracket before you ran across 'tough times' - you're probably looking at 35% ($4200 in taxes, leaving $7800 of your $12000 withdrawal; or $8,050 in taxes leaving $14,950 of your complete $23k withdrawal - essentially, you will only get $65 for each $100 you withdraw)



But some other questions before you do this (401k early withdrawals are a last resort effort):

• are you personally unemployed? (ie only husband is working)
• have you applied for unemployment benefits?
• if you are still employed, would you be able to post a budget for critique? (you may just have a budget problem - but I don't know enough about your situation)
• would you be opposed to posting your budget either way?

From: Roth IRA Withdrawal Rules

Distributions After a Roth Conversion
If, you’ve converted money from a traditional IRA to a Roth IRA, things get slightly trickier.

Any distributions of converted amounts (assuming they were taxable at the date of the conversion) will be subject to the 10% penalty (though they’ll be free from ordinary income taxes) if the distribution occurs prior to the first day of the fifth year after the date of the conversion. If, however, the distribution was for a “qualifying reason” or you meet one of the “other exceptions” above, the distribution will be free from penalty.

If the conversion included amounts that were not taxable (because they came from a nondeductible IRA), those amounts will not be subject to the 10% penalty even if they are withdrawn from the Roth prior to the first day of the fifth year after the date of the conversion.

[scfr]

$350 smaller monthly paycheck x 12 months = $4,200
Why would you need to pull out $12,000 or more?

I know you don't want to hear "don't do it" so instead I will say "challenge yourselves to see how long you can delay doing it."

For the month of January, your husband will be bringing home $350 less. For now could you just focus on that $350, and try to make up the shortfall somehow, by cutting back in other areas or adding a bit of additional income somehow? Once January has been covered, then you can start on February. What looks like an insurmountable problem right now might be manageable if you break it down in to smaller pieces.

[KTP]

Very sorry to hear about your troubles. A lot of us on here sometimes don't always remember that there are many people who have a lot more worries than where to get an extra 0.25% return on their $20,000 emergency fund.

I would exhaust almost every other possibility before tapping the 401K to pay bills. If you don't have any home equity or other sellable assets, here is what I would do right now:

cut budget back to bare minimum (no cell phone, cable tv, eating out, etc.)
Cash husbands paycheck
Put 20% in savings account for emergency fund
buy food
buy gas for car
pay electric, water, garbage and phone bills
if anything left, pay house payment
if anything left, pay credit card
if anything left, pay medical bill

If your situtation does not improve soon, may have to think about giving house back to bank and defaulting on credit cards. Your 401K is untouchable by creditors, which is why it should be the very very very last resort to tap when you are in bad financial difficulty.

[skydivingchic]

As jpg alluded, how much you lose to taxes depends on your tax bracket. So whatever your tax bracket is +10%. Don't forget state income taxes if that applies to you.

I agree with scfr - your paychecks will decrease by $4200 total for the year, so why the need for $12,000+? KTP mentioned a very important point - your 401k balance is protected in bankruptcy, so if your option is to default on CCs, car loans, and/or your mortgage, you should be looking long and hard at that rather than raiding your 401k.

If you are willing to post a budget, there are a lot of smart people here who are willing and able to make suggestions.

[disneysteve]

I would not touch the 401k.

$4,200/year is $80/week. Do as skydivingchic suggested and post your budget for review and suggestions.
Is your husband still contributing to the 401k and, if so, how much?

Another thing to look into is if there are any options with the health plans. Can you raise your deductible? Switch to a plan with a higher copay but lower premium? Also keep in mind that what you pay in premiums may be tax deductible and reduce your tax burden making the actual cost somewhat less than $350/month.

I'd exhaust every other possible place to come up with the money. Raise the deductibles on your auto and home policies to lower your premiums. Trim the food budget. Cut any extras like cell phones and cable TV. Etc.

Do both of you work? Can either or both of you pick up an extra job? Earning $80/week is really not a big challenge. Deliver pizzas a couple of days a week and you'll probably earn that much between pay and tips. Do you have any stuff you can sell on ebay or craigslist? Babysit? Walk dogs? Mow lawns? Shovel snow? I could have made more than $80 this week just clearing snow from 3 or 4 houses after we got 12 inches of snow Sunday night. Basically, I'd look for every conceivable way to cut costs and boost income to make up that $80/week and leave the 401k intact.

[tulog]

If you must touch the 401k, then why not take a loan from the 401k instead? Thus, no tax consequences whatsoever provided you repay the loan. Many plans allow a loan of up to 50% of the balance, which can be repaid over 5 years.

[disneysteve]

If you must touch the 401k, then why not take a loan from the 401k instead? Thus, no tax consequences whatsoever provided you repay the loan. Many plans allow a loan of up to 50% of the balance, which can be repaid over 5 years.

While I would count that as a last resort option also, it is an interesting thought. Borrow enough for one year's worth of insurance premiums ($4,200) but be able to repay it over 5 years ($70/month). It will be a lot easier for you to come up with an extra $70/mo. than an extra $350/mo. Then, during the year, work your butts off to find a way to cover that expense going forward so that after the year is up, you will be in a position to pay for the health insurance on your own and not have to continue to suck money from the 401k. And also work to repay that loan as fast as possible once you cut your expenses and boost your income.

Still not a great plan but a lot better than cashing out the 401k.

[cjscully]

You need to focus on your monthly bottom line as has already been pointed out. You're upside down by $350 per month. Borrowing or cashing out your 401k won't address that. Once that transaction is completed you'll still be upside down by $350/month.

You have to work on raising income and reducing expenses until you're no longer upside down. If you don't deal with this one point, you will burn through whatever you get out of the 401k and you'll then need more money because you're living beyond your means.

[disneysteve]

You need to focus on your monthly bottom line as has already been pointed out. You're upside down by $350 per month. Borrowing or cashing out your 401k won't address that. Once that transaction is completed you'll still be upside down by $350/month.

You have to work on raising income and reducing expenses until you're no longer upside down. If you don't deal with this one point, you will burn through whatever you get out of the 401k and you'll then need more money because you're living beyond your means.

Very well put. Cashing out the 401k doesn't fix the problem. I've said many times that you can't borrow your way out of debt. If your expenses exceed your income, there are only two ways to fix that: lower your expenses or increase your income.

[marjo1950]

cashing out our 401K

Sorry this reply is long but I'm not good at being concise........

I couldn't see an option to reply "individually" to each of those who replied to my posting so I assume I just answer here and all of you will see it.
First off, I'm amazed at how caring and encouraging you all are. I really just wanted to know how much we'd pocket (after penalties and the taxes we'd have to pay) and I got some good insight on that...BUT...the fact that you all took the time to make suggestions on how to avoid cashing out our 401K really impressed me. You don't even know who I am but you are willing to help. I will share your replies with my husband and we will seriously re-think things. However, I will add a little more info' here:
The reason for wanting to cash out a big amount isn't just the $350 we need because of insurance. A year and a half ago I had to quit my job (I cleaned a 2 story church) because I hurt my arms and my doctor said if I didn't quit my job they wouldn't get better and might get worse. So, when we lost my income we had to go into our savings and it will be depleted when we pay our bills this month. I also need both knees replaced and have a hip replacement that is 16 yrs. old. Hip replacements generally last just 15-20 years so I try hard to be careful what I do so that it will last, as long as possible, before needing to be replaced. If I could get my knees fixed it would be a “little” easier for me to find work but we just don't have the deductible we'd have to pay for the surgeries (not sure exactly how much it will be but know it will be "at least" $8000). I can only have one done at a time so would try to set it up to get them done in the same year so we'd have to pay less out of pocket. Anyway, I'm really not trying to give you all a sob story but my physical limitations make it hard to find a job I can handle physically. I'm getting to where I feel I will have to just DO IT...find work and tolerate the pain. I am in pain now and it would increase if I have to stand too long or use my arms and hands to much...even typing here is a problem but I don't have a “time limit” to get this written so I can take breaks and give my hands and arms a break. I tell you all this because I am really wanting to find work. It’s just hard when you have to be more picky. As far as my husband's job, he wakes up each day around 4:30am and never knows from day to day if he will get off work by 4:30pm or if projects will be thrown at him, at the last minute, where he ends up having to stay one to two hours longer. I don’t want to give too much info’ on his job in case someone on this site would figure out who we are. He's almost 60 and if he held another job he'd not be able to handle it physically. A few years ago he held down 2 jobs and it really took its toll on him back then. Plus, not knowing when he'll get off each day makes it hard for him to commit to arriving at another job by a certain time each evening. I get frustrated because, even though I just turned 60, I have a good mind and am not lazy. I feel if I didn’t have physical limitations I could hold down a decent paying job. I keep searching the internet, too, for something I could do on the computer from home but there are so many scams out there that I am way too afraid to try some that I’ve found because they say “If it sounds too good to be true, it probably is.” I feel that if I could work from home I’d be able to take breaks from my online work and be able to handle the typing or such. I could also regulate how much I sit, get up and walk around (which all help in managing pain).
One of you mentioned getting some of the equity out of our house (we have about $20,000). We had checked on that but we’d have to pay over $130 a month to pay it back (and that’s just paying the interest) and with us already struggling to pay our monthly bills, we can’t add another payment to our budget. We do not spend money on expensive things or activities. My sister has teased me about how I even question spending a few dollars at Mc’D’s…smile.
In a nutshell, we feel if we can have money in the bank for the next year…not just to cover our bills but some to fall back on in case our old car quits on us (it has 250,000 miles on it) or some other emergency pops up, it will give use some peace of mind until I find work or my husband finds a different paying job, etc., etc. When you’re overwhelmed like we are, it’s hard to think straight and we know that the feeling of being at a dead end could make us do something we’d regret in the long run (nothing illegal, though…smile). So, thanks for giving us some “food for thought.”

[KTP]

Hey! Just a sec, getting over the headache from that wall of text!

Okay. Hmmm...you have big problems. I think you need to figure out a way to survive until SS kicks in for both of you, and probably you need to take it at age 62 so you can have something to limp along until medicare kicks in (when is that, 67 now?). I think this means that you do NOT touch the 401K, instead, you should actually max your contribution to it, and perhaps also contribute as much as possible to Roth IRAs. This sounds crazy, no? but then what you should do to live and eat is get as much equity out of your house as possible, then use the equity loan to make the house payment and pay the electric bills. Keeping the 401K money and having the money in the Roths (up to $12,000 a year combined can be put there) will protect it from bankruptcy, which I predict is actually where you will end up, especially if your medical condition worsens before you reach medicare. It sounds harsh, and is probably really bad for the banks and credit cards (shed a tear here please) but I think that might be the smartest move for you if your situation has been described accurately. Maybe DS or others have a better way.

What I think is going to happen is you are going to tap the 401K and use it to pay your medical bills, mortgage and other stuff and then end up filing bankruptcy anyway. With my method, you will have $30,000+ in your 401K and $12000+ in a Roth IRA AFTER bankruptcy, and then you can rent an apartment and live off SS as best you can.

Tempted to erase all of this, because it sounds really bad. I certainly would rather see you able to get a job and keep current on everything, but with those medical issues..I dunno.

Edit: I just read that in some states an IRA may not be exempt from bankruptcy, and also the court can disallow the exemption if they feel it was used to "hide" money just prior to a bankruptcy. I don't think it would be an issue if you were able to contribut to an IRA for several years before things got too bad though. I am 99% sure the 401K is untouchable in every state due to a federal law.

Best of luck to you! Happy New Year too.

[MaxPowers]

I think you need to figure out a way to survive until SS kicks in for both of you...

Correct me if I am wrong, but my mom told me that a married couple can only use 1 person's SS. Which is why many older married couples get a divorce. Unfortunately for my mom, my dad died recently at 68, so she is working on getting his SS and not her own.

[jpg7n16]

Correct me if I am wrong, but my mom told me that a married couple can only use 1 person's SS. Which is why many older married couples get a divorce. Unfortunately for my mom, my dad died recently at 68, so she is working on getting his SS and not her own.

It was my understanding that SSI pays either the main income earners benefit plus the spousal benefit, or pays each person's SSI benefit (if both qualify); whichever is higher.

--------
For your mom, if your dad qualified for full SSI, she should be able to get survivor's benefits; or her own, whichever is higher. You should get her to speak to a Social Security representative to see what her options are.

Social Security Survivors Benefits

[jpg7n16]

Marjo,

If you'd be able to post the details of your budget, we may be able to help you narrow down your focus to see what your best option is for making it through the year.

Either way, I don't think you should take out $12,000 at all. 1st- see if we can help find a way to make your budget work with the income you've got. 2nd- see if there are any jobs that outsource to typists at home. It doesn't have to be an internet job; other companies will pay for typists at home, where you can take the time you need. Your post reads intelligently, and isn't full of spelling/grammatical errors, so you might be able to find something.

And only only as a last resort (or if you're gonna do it no matter what we advise), only take out each month what you need.

Yes it'd be nice to have some peace of mind, but it'd also be terrible to withdraw $12,000; pay 4000 in taxes; only get $8k of the money - and then get a raise at work, or find a new job - and realize you did all that for nothing.

[also if you don't mind posting in paragraphs, it makes it easier for us all to read

If you want to reply to a specific post, you can click the 'quote' button in the bottom right hand corner of each post. And once it loads, you can click in the post to delete parts that aren't relevant, if needed.

Or to reply to multiple posts at one time, click the little button with quotation marks and a plus sign. That is the multi-quote button. Click it for each post you would like to reply to, and it should turn orange with a minus sign. After you've clicked all the posts you'd like to reply to, then click the 'Post Reply' button; left side bottom at the end of the last post in the thread.]