Do you know that you can use your 401(k), without using it up? Apparently about 45 percent of employees leaving 401(k)-generating jobs don't. A study by HR consulting firm Hewitt Associates has found that those 45 percent are now cashing out their 401(k) plans when they leave a job. That's an alarming statistic, especially when it can be entirely avoided.
We know that, in order to retire, most people must continue to grow their defined benefit plan by 30 percent after they leave their job. So cashing out not only costs them a 10-percent penalty tax and current-year income taxes of up to 35 percent, it also takes away any hope of earnings from future plan growth. Oh, and there's no longer even a basic retirement account to tap into when the going gets tough.
If you're tempted to cash out, there are other options.
Once the funds are rolled over to an IRA, you can:
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1.
Take a 60-day loan from your IRA once every year -- as long as the money is put back within that timeframe.
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2.
Withdraw money without penalty for medical expenses above 7.5 percent of your income, health-insurance premiums while unemployed, going back to school, paying for family member's higher education expenses, or a first-home purchase.
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3.
Withdraw without penalty any IRA money you've deposited since filing last year's taxes.
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4.
Do an "I'll scratch your back if you'll scratch mine" arrangement, where -- if your IRA is with a custodial firm that allows self-direction into private notes (and a growing number do) -- your IRA can make a loan to a non-family member. A non-family member's IRA also can make a loan to you. Both loans must be paid back with market-rate interest, to comply with the ERISA codes that regulate retirement account investing. But you'll still have your retirement account and your friend will still have theirs.
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5.
In the case of a Roth IRA, which are the IRAs where you'll pay taxes on your contributions as income now but pay no taxes when you later make withdrawals, you can withdraw your contributions without penalty as long as they've been in the account for at least five years.
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These strategies are relatively simple, and are being used by thousands already to get them through the tight spots and back on track to a well-funded retirement. Next time you're tempted to take a costly withdrawal, take a moment first to see if any of these options would work for you. You may save yourself a boatload on taxes and fees, and save your retirement in the process.Â
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| Â |  |  |  | Â |
| Â Jennifer D. Meacham, Gather Money Correspondent | ||||
Jennifer's column, "The Bottom Line," is published every week to the Gather Essentials: Money channel. Jennifer is a business and personal finance columnist who covers money matters for RedwoodAge.com and real estate news for RISMedia, and co-authored the best-selling retirement investing guide "IRA Wealth: Revolutionary IRA Strategies for Real Estate Investment" (Square One Publishers, New York). Keep up on the latest news and analysis into how you can take control of your business and personal financial future by joining Jennifer's "Self-Directed Investing 101" network. | ||||
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Comments: 90
Grandma said put money in a savings account and don't touch it unless there is no other way to pay. She did well doing that. If I had anything to save these days, that's what I'd probably do. It's simple and I don't have to pay someone to tell me how it works.
Good point MJ. Wachovia Bank has a new savings program that matches 5 percent and pays 5 percent interest -- a solid 10 percent return annually. And no management or mutual fund or brokerage fees.
So until you ready to start managing investments or hire someone else to do it, you're right on the money by going the savings account way. However, you'll want to look at the options in savings accounts to make sure your putting your money to the best possible work there.
My PayPal account pays 2.3 percent right now for money held there, once you enroll in the free Money Market option. Meanwhile, I'm also doing Bank of America's "Keep the Change" program, where every purchase is rounded up to the nearest dollar and that difference is both deposited into a free-for-the-first-year savings account and matched 100 percent by Bank of America for the first three months and 5 percent for the next 9 months up to $250. An extra $250 in my savings isn't much, but it's free -- and provides a whopping 100 percent return if I'm able to tap out at the $250 amount within the first three months.
Meanwhile, you likely have a 403(b) plan. Here are two articles I wrote about 403(b)s, which are the public-sector version of the 401(k). It may be too technical, but it will at least give you an idea of what you can do with your 403(b) money once you retire from your state job or move onto one in the private sector....
The Bottom Line EXTRA: Real estate options in public retirement plans
The Bottom Line: Get cozy with rolling over your 401(k), 403(b) or IRA
I'll check into the keep the change program again. I did that once before and it drove me crazy with all the little extra book keeping in my finance software.
I'm curious about other ideas for investing emergency fund money that's safe and no penalties to withdraw if it's needed.
I have heard of some rollovers though that have been fraught with problems, but this is rare. If any one here runs into a problem, just pop back here and we'll do our best to give you the information you'll need.
P.S. Thank you Karen for stopping by with a comment. Always appreciated.
All the best,
(Fake) Tom Gerace, (Fake) CEO
You may want to consider keeping change out of the tub. One errant penny down the drain could spell trouble for your plumbing (a bottom line nightmare).
Additionally, though this strategy does indeed sound like fun, the disadvantage is that inflation lowers the value of the money in the tub by at least 2 percent each year (usually 3 or 4). Unless you want your funds to "shrink in the wash," you'll need to park it somewhere where interest or investment income will help make up the difference.
Just my two cents.... (one of which did take the tub plunge; so I'm speaking from experience with my advice above) ; )
Good point on inflation losses; maybe I'll start swimming in T-bills or stock certificates.
All the best,
(Fake) Tom Gerace, (Fake) CEO
Many banks offer a "night sweep" option where money left in accounts overnight are moved into money market accounts for interest growth, then returned in the morning. Yes, there is a chance of loss. But that gains have been so consistent and the shame institutions would face would be so great that I'm thinking interest is about "guaranteed."
The advantage of money market accounts over a CD are that the money isn't locked up (with penalties for withdrawal, like money held in certificates of deposit). Meanwhile, there's no need to wait for a stock broker (or pay them commissions) to sell your holdings in order to use the cold hard cash.
Money market accounts are the only way to go about savings these days, in my opinion. They address the best of all worlds.
Any feedback on this Carol?
PayPal is offering 2.3 percent right now; all you have to do to get that interest rate, on money parked in a PayPal account, is simply to request it!
Absolutely Carol. That's the way to do it.
My pleasure Carol P. Any time.
P.S. And if you find your IRA custodian now, my understanding is that they may allow you to actually use the rollover money for the next 60 days as long as you get a separate check to them (for the amount you do want to continue tax sheltering) within that time frame.
You're right to bring up the options that people have even within their own employer accounts. Employer retirement plans like the private employers' 401(k) or the public employers' 403(b) do indeed allow low-interest loans to yourself directly out of the account (not so with the IRA).
If I were to leave the company and roll my 401k into an IRA, would I be able to withdraw money that I deposited into the 401k since filing last year's taxes or does that only apply to any deposits you make once it becomes and IRA?
I'll check into your question Dana, just to be sure. Meanwhile, thank you. That's what I'm here for. ; )
There are indeed many ways to take loans from a 401(k). Here are the details from Fidelity Investments, which administers 401(k) plans:
"If your plan allows for loans (not all plans do), the most you can borrow is the lesser of 50 percent of your vested balance or $50,000 ... Taxes or penalties only come into play if you leave your employer without repaying your loan and/or if you don't repay your loan on time while you are still employed."
"You should note that while it may seem like a loan is tax-free, it isn't. Over time, you will pay taxes on the money twice. First, loan repayments are deducted from your paycheck after income taxes have been withheld, then as repayments are reinvested in your account they are characterized as pre-tax money. So, when you withdraw from your account, you will pay taxes on the money again."
For those currently in the zero-tax income bracket, due to having more deductions than income, the double taxation is a non-issue. For those in higher income brackets, however, the 15 percent or higher re-tax on 401(k) loan money wipes out a 401(k) loan as an economical option when compared to just getting a conventional 8 percent loan.
The Bottom Line: For those that can't right now qualify for a conventional loan due to a low credit score, and who can assure they'll be able to pay the 401(K) loan back every month, a 401(k) loan may indeed be a viable option.
1) The same annual-deposit-change-of-mind exception does not apply for 401(k) contributions, because the deposit is reported every month or quarter to the IRS by your employer.
2) However, he says, if the 401(k) deposit is not yet reported to the IRS, the employer "may be able to amend that payroll deduction."
However, now we just borrow from my husbands 401K when it is an emergency. For instance, our son in law had a stroke, father in law was in hospital dying and we had to stay in a motel for 2 weeks to be near family at this time. We not only had an income because my husband had already used up all his vacation time but we felt it was more important to be with our family. We got a hotel room and took care of the Grandkids in it and made arrangements for all the family members to have access to keys so they could shower or sleep when they needed it.
Both our son in law and father in law was in different hospitals and both were a two hour drive from our home.
We borrowed from his 401 K to live and care for family at this time.
We paid it back in no time out of his checks when he went back to work.
My pleasure Debra H.! You too.
Tomi, thank you so much for stopping by. I really appreciate the kind note.
All my best,
Is the stock market looking up anytime soon? We are really concerned. We are afraid to even look at my husbands 401K because we know we lost a lot. We were counting on that to keep us living when we retired or lost his job. Scary stuff now
Conditions aren't likely to improve until 2010, according to forecasters at the Association for Business Economics. You'll want to look for rising consumer confidence levels in any of the news reports you read. Historically, that's the ticket to a rebound in stock prices.
Personally, I will start slowly moving out of cash in the second and third quarters, moving from a short term trading strategy more to value investing strategy.
Cashing it out now will cause you to lose 10 percent more of the value from the I.R.S.-levied early withdrawal penalty, plus you'll have to pay income taxes on the cashed-out amount at your current rate. If it's 15 percent, then cashing out now will cause the balance to drop another 25 percent this year alone.
Consider your options! Even leaving it in the stock market likely won't cause you another 25 percent drop at this point!
Here's a post of mine with insight into this process which you can read along with joining my group Self-Directed Investor 101. Meanwhile, here's a link to custodians that allow real property purchases as part of their managed IRA portfolios: self-directed.info/custodians.htm,
I hope this helps!
Just commenting you back, thanking you for a comment you made on one of my articles or pics! I always pay back the comments!
YOU ARE GREAT.
Thank you so stopping by Beverly. Glad this helped.
~thanks for the info Ms. Meachum ~j
Thank you for the vote of confidence Jean. I'd say that I've reported more on this topic of self-directed account investing than any other journalist, in the U.S. or beyond. I turn to experts in the retirement planning field to find the facts and figures that go into my reporting.
I thought you could lend to yourself from your IRA, for example, to make energy improvements on your house. I'm almost 59.5, so I may just be able to take some out to do this, but I was just wondering.
Also, I wanted to say that Advantis Credit Union in Portland pays about 4% on an account that is called a Fusion account, up to $35,000 I think. The account is checking and savings combined. It resets month to month, and requires 12 credit card transactions, an auto deposit or pay, and looking at your statement on-line to get that rate, but it's not that hard to do all that.
Thanks for the heads up on the Fusion account Mary.
As to your question on IRA withdrawals, you're lucky in that you will be able to take funds penalty free from your Traditional IRA as of age 59½. (With Roth IRAs, you can make penalty free withdrawals after just five years from making the initial deposit.)
The basic rule for IRAs is that there can be no "self dealing." You can't directly do business with or use your IRA funds without the funds you withdraw being counted as an early withdrawal where the 10 percent penalty immediately applies.
However, one of the exclusions is that, if your current home is your first home, you can withdraw funds without penalty to "rebuild" it. Here's the full list of exceptions to the age 59½ rule:
You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.
The distributions are not more than the cost of your medical insurance.
You are disabled. (You are considered disabled if you can furnish proof that you cannot do any substantial gainful activity because of your physical or mental condition. A physician must determine that your condition can be expected to result in death or to be of long, continued, and indefinite duration.)
You are the beneficiary of a deceased IRA owner.
You are receiving distributions in the form of an annuity.
The distributions are not more than your qualified higher education expenses.
You use the distributions to buy, build, or rebuild a first home.
The distribution is due to an IRS levy of the qualified plan.
The distribution is a qualified reservist distribution.
Outside of that, your only non-penalty options for tapping your IRA funds directly are 1) the 60-day withdraw-and-put-back-in option and 2) withdrawing last year's contributions before the due date or extension date for filing that year's tax return.
Whew.... ; ) Does this information help at all?
This is well written and well researched. I don't like 401K plans or IRA plans. Of course I'm past the penalty age for early withdrawal but many people are not and if they need their money it costs them to get it and in todays economy more and more people are needing to withdraw their money and will not be able to repay it. There's something not right about that. We're living in scary times and feeding the family will come before worrying about the penalty of early withdrawal.
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Interesting perspective Lee. I would have to concede that, in this and many other cases, the early-withdrawal penalty does indeed equate to a 10 percent additional tax on those who arguably need the money most.
The concept of the penalty is a good one, to encourage long-term participation so taxpayers do actually save for retirement instead of tapping their 401(k) for incidentals. We all know how quickly an account can dwindle as soon as that happens. However, if there are changes to be made in regards to 401(k)s and the current stimulus packages, I'd take a look at governmental restructuring of 401(k)s and Traditional IRAs so that -- like Roth IRAs -- contributions can be withdrawn without penalty after five years in the account. This could provide a simple way to boost consumer spending power (a key economic indicator) while funneling the 10-percent savings directly to the consumer's pocketbook (saving the I.R.S. a heck of a lot in stimulus-check stamps).
Meanwhile, the strategies in the post above will have to do.... ; )
HTML clipboardTo add to our earlier conversation here, people who withdraw money from one of the retirement plans known as a SIMPLE plan (but only those who first funded the plan in the past two years) are levied a 25 percent rather than 10 percent early-distribution penalty. Of note is that these plans are designed for the smallest of small employers. It's hard enough for many of these folks just to save, let alone be more than doubly penalized for one day having to use the funds.
Great info. Thanks!
However, now I am considering moving it into a self-directed IRA and possibly using some of the money to buy some more Real Estate; it's such a good time to buy, right now.
"Money may not be taken from you to satisfy a judgment, which means your retirement will not be negatively impacted because of a judgment against you....The exception to the exclusion of retirement accounts from judgments is in the case of an IRS tax lien and cases where plan administrators set up accounts for embezzlement of the plan funds." Additionally, at least one report indicates that if you have IRAs totalling more than $1 million then that excess could be tapped to paid a debt. Read more at "Can You Lose Your 401(k) or IRA From Being Sued?" http://www.ehow.com/about_7495206_can-401k-ira-being-sued.html#ixzz1jHzCELt6
My additional research finds that the laws could differ from state to state. However, California appears to be the loosest as far as allowing IRA collections in law suits. Here are its rules from the Code of Civil Procedure statute: Your IRA and other retirement accounts are protected to the extent that you need them to survive during retirement.
Meanwhile, here's a Gather article I wrote that may help others looking into rolling over their funds from a 401(k).
I do hope this helps. Think you could track down the original spot where you read that the IRA can be tapped in a suit? I was unable to get direct iinformation from the IRS website related to this question, so for good measure I'd like to fully check this question out to assure that no laws have changed related to IRA access.