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My husband has a 401k from his previous job which is worth about $13,000. He wants to take it out and use it. His new job has a 401k option that he has not looked into yet. I was wondering if we did take it out (which would be about $4100 in penalties and taxes, I think) and opened an IRA in the amount of $5000(minimal) if that'd benefit us at tax time and we would still have the $3000.

Also, we make way less than the $60000 cut off. So, it appears it should be fully tax deductible. Is this true or am I just imagining how I think it would work?

My first answer to him using the 401k was a flat 'No.' However, it seems like the more I look into it, even though it's less than half in what was paid in, it looks feasible and without too many negatives. Am I completely misinterpreting the tax/401k jargon?

Oh and just in case the right answer is to roll it into a new 401k employer benefit, which is probably a 457 deferred compensation plan (he's now a county employee), how do loans against it typically work? E.g the repayment time, payment amounts, and interest rates?

  • What is the name of the 457 plan? Is it a state-administered plan? – duffbeer703 Apr 17 '11 at 14:35
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Rather than rolling the 401(k) to a new employer's plan, you should roll it into a traditional IRA. You get more options for the money, there's no limit on how much you can roll over, and you have more control over the money. If you do a direct rollover, there's no taxes or penalties involved.

I'd recommend against taking any money out of the 401(k). With the numbers you give above, it's like borrowing money at 31.5% interest, which is pretty high, and you're sacrificing your future retirement. If you leave that money alone to grow with compounding, you'll have a lot more when you retire. If you're not familiar with the concept of compound interest, it's worth reading up on - the numbers will blow you away.

At the very least, if you desperately need to get $3000 out of it, take out just enough to net $3000 after taxes and penalties (not quite $4400 using the numbers you give) and do a rollover with the rest. At least that way, you're keeping more in the IRA (just over $8600, vs the $5000 in your proposed scenario).

Overall, I really recommend you find a way to accomplish your goals without touching your retirement savings.

  • Part of the issue is that he thinks he can accomplish his retirement goals at his new employer. He's 30 years old. Trying to grasp the concept of retirement seems almost frivolous when we have just started our lives together and getting settled. He will also get state hazard retirement, but watching the news and other states budgets, that seems more unreliable all the time. Do you think his age matter? Thanks for your input. – user3354 Apr 17 '11 at 16:46
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    If your husband belongs to a union, he should get the full rundown on the pension program and understand the risks. In New York, for example, public pensions are guaranteed by the full faith & credit of the state, per the state constitution. It's never to early to be thinking about retirement, because other priorities will popup. For example, when you have kids, you have to start thinking about education! – duffbeer703 Apr 17 '11 at 17:05
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    @AmyP: IMO, if he gets into the habit of looking at his retirement savings as a pool of money he can access whenever he "needs" it, he'll never achieve his retirement goals. The younger you are, the better, because you have more time for the compounding to work, which means you'll have to save less money over time to achieve the same level of retirement savings. – Randy Coulman Apr 18 '11 at 0:12
  • 30 too far from retirement? My 12 yr old opened a Roth IRA since she had babysitting income this summer. Never too soon to start. Never. – JTP - Apologise to Monica Apr 22 '11 at 14:57
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Try to avoid actually pulling money out of your retirement savings. Not only are you paying that stiff penalty today, but you're actually stealing form your future.

Many 457 plans allow you to borrow against the balance, usually up to 50% of the plan balance. I'd roll the 401k into the 457 and borrow against it if you really need the money. Borrow a little extra to help you make the first few payments if you need to.

  • It is a state administered plan. I don't really know the name of it. Need is a funny word. I don't think we need any of it, but my husband does and he's the one I'm trying to convince to just leave it. Thanks for your input. – user3354 Apr 17 '11 at 16:41
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I would like to buy hubby a beer and talk some sense into him. Do you have 2 years gross income saved as your retirement balance? That's about where he should be at age 30. I wrote about this in an article Retirement Savings Ratio. Blowing the 401(k) for anything less than an extreme emergency is downright foolish.

The decision whether to roll it to an IRA or the new account isn't so simple. If you roll it to new plan, yes you can borrow, up to 60 months at a low rate, 4% or so. Taking the cash and then making an IRA deposit just means paying the penalty for nothing, unless you manage it just right, depositing the amount within 60 day, etc. You don't mention what he wants to do with it. You need to sit down and have a long "money talk."

Keep in mind, if you oversave, it's easy to retire early, or at 50 just stop saving, spend every new dime. But it's something else to turn 50 and realize you will have to work till you die. I've seen both situations. (I am 48, the Mrs, 54 our multiple is now 13. The target is 20 to retire. The house is not counted as it can't be spent. The mortgage IS counted as it must be paid)

Edit - as I read this again, I see the OP asked about opening an IRA in the same year they withdraw the 401(k) and pay tax and penalty. Wow. I also see her user reverted to generic, which means, I think, she's never returned. I hope they made the right decision, to keep the money in retirement accounts. Hubby never even said what he wanted the money for.

  • @ JoeTaxpayer- what do you mean by multiple? – user3354 Apr 21 '11 at 3:16
  • Retirement saving need is more a multiple of current spending than an absolute number. If I expect to be able to withdraw 4% per year, 20x my final income is what I need to replace 80% of that income. So in discussions, I talk about multiple of current income. I linked to a spreadsheet in my answer whit makes the concept clear. Update with current age, income, savings. – JTP - Apologise to Monica Apr 22 '11 at 14:53
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If you really want to use the money roll it over to the new companies 401k and then take a 401k loan out for whatever the expense is. (Assuming the retirement plan allows them.)

Generally 401k loans are frowned upon for all sorts of reasons however if the alternative is to just flat out withdraw the money it is a slightly better solution.

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