2008 July | IRA Rules

Archive for July, 2008

Ira Withdrawal Hardship

July 23rd, 2008

Question: Need to cash 401k. Is it possible to roll it over and then cash it in?

I need to cash 401k. Please don’t lecture about penalties. I’m aware. I can’t just cash it without quitting my job, but not able to quit yet. I have taken one loan from it and also one hardship withdrawal. Is it possible to roll it over(I understand the loan balance will be withheld) to a private account(IRA, etc.) and cash it in from there(yes, I understand there will be taxes and penalties)? The main question here is: CAN IT BE DONE?
Supplemental: What kind of penalties and taxes will I incur? Account balance is about $25k.

Answer: Received your clarification in time. Thanks

Most plan administrators will not allow you to surrender the 401(k) (ESOP)until you have terminated employment or retire. And most companies won’t let you roll it over to an IRA because rolling it over to an IRA is the same as closing the 401(k)(ESOP). They will, however, let you stop making contributions. These plans require a certain percentage of employee participation to keep the plan from becoming top heavy in favor of the highly compensated owners and managers. You would need to look through your plan documentation to see if there are any special rules regarding cashing in while still working, but that option is very rare.

But here is something to consider. Once you cash in the 401(k), the loan you have becomes a distribution subject to income tax and early withdrawal penalty. That means you have to add $5,705.65 to your total income for 2008, plus the value of the 401(k) (ESOP) of $28,965.72, assuming you are 100% vested.

From the information you provide, The surrender of the ESOP, 401(k), plus the inclusion of the loan and your annual income will put you in the 28% tax bracket. However, mortgage interest deduction, (if you own a home) and other deductions you may have could reduce that tax bracket somewhat.

So, the first thing you have to do is calculate the tax and penalty on the loan, and then the tax and penalty on the remaining $28,965.72. If you are allowed to surrender the remaining amount, they will automatically withhold 20% from the distribution which will be added to your total withholding for the year. If you terminate employment and roll it over to an IRA and then surrender the IRA, the company you used for the IRA will also withhold 20%.

So, for example. let’s say you are in the 28% tax bracket. You would owe $1,597.58 in tax on the loan plus $571 withdrawal penalty for a total of $2,168. Then you owe $8,110 on the remaining $28,965.72 plus $2,897 in penalties. This would give you, in this example, a total of $13,175 in taxes and penalties.

In this example, by the time your finished, you would lose almost 46% of the $28,965 in taxes and penalties. This is assuming you are still in the 28% tax bracket after calculating your taxable income. After looking at the amount you owe, I don’t think it would be worth it to take such a large tax hit. You would only have $15,790 left.

Because part of your retirement is in an ESOP, you still need to follow the same rules as the 401(k) when you take the money. 10% penalty for early withdrawal before 59 1/2, and Required Minimum Distributions at age 70 1/2. The only difference is part of your money is in your company’s stock instead of other equity investments.

This is how it is set up. The trust fiduciary allocates the shares of your company’s stock among the plan participants’ accounts according to a pre-established formula. As your length of service with your company increases, he or she acquires rights to the shares in his or her individual account. (This process is known as “vesting.”) When an employee retires or terminates employment, the employee generally receives a distribution of his or her vested benefits in the ESOP in the form of cash or company stock. If the distribution is in the form of stock, the employee can choose to either hold or sell the stock. If the stock is not publicly traded, the employee must have the right to sell the stock back to the company at its fair market value. This is not a requirement, however, if the stock is publicly traded, as the employee can simply sell the stock on the open market. The key phrase here as it applies to you is “retires or terminates.” The other thing to watch out for here is the viability of your company. If the company goes bankrupt, the value of your ESOP could drop to zero.
Your situation is the main reason I advise my clients not to put more than 7% of income in an IRA, 401(k), etc. I usually recommend they save 15% of income each in fixed savings vehicles until they have 50% of income saved. Then start putting money into qualified plans at the 7% rate. Too many people today have been maxing out their 401(k), then need money and wind up taking large penalties in trying to get money out of the qualified plan.

Stocks, Mutual Funds & Retirement Investments : Withdrawal Rules for Traditional IRA