Message Font: Serif | Sans-Serif
 
No. of Recommendations: 0
I'm seriously considering an early withdrawl from my 401k to eliminate some serious debt. I've investigated budget re-arranging, paying the debt down over a period of time, but can't wait the 2 years to complete the debt elimination. This will not be a total withdrawl from my 401k, just a percentage. The question not answered yet is the tax issue. I know their is a 10% penality cost plus 20% Federal Tax hit. I realize the lost investment opportunity to this idea as well. What's the best way to figure the total tax impact of this debt elimination possibility? I'm just trying to understand if this is a realistic opition.

Helpful opinions and advice are needed.
Thanks
Print the post Back To Top
No. of Recommendations: 0
BobLOfthouse asks,

The question not answered yet is the tax issue. I know their is a 10% penality cost plus 20% Federal Tax hit.

The 10% penalty is correct, but I don't know where you got the 20%. An IRA withdrawal is taxed at ordinary income tax rates (i.e. 15%, 28%, 31%, etc.) You'll also have to pay state income taxes if they apply.

intercst
Print the post Back To Top
No. of Recommendations: 0
Withholding rate on distributions (even early ones subject to the 10% penalty) is 20% unless you designate another higher rate. Generally, you have to elect a higher withholding rate if you want it and you have to elect to have state taxes withheld. Otherwise, only 20% federal is withheld.
Print the post Back To Top
No. of Recommendations: 1
Withholding rate on distributions (even early ones subject to the 10% penalty) is 20% unless you designate another higher rate.

Correct - but this is only what is withheld when you take the distribution, not the total taxes owed.

In California (where I live) I advise clients that taxes on an early withdrawl will eat up half of what you take out. 31% to Federal Tax, 10% to Federal penalty, 2.5% to the state penaly, and 8% to state income taxes. (There is a small reduction in the effective Federal rate for the increased state tax itemized deduction).

Another possibility for you might be to borrow against your 401k plan. There is a BIG WARNING here though. This will only be viable if you meet all of the following:
1) Are happy with your job and won't go looking for another before the loan is repaid.
2) Are secure in the job and won't be fired/laid-off/downsized/right-sized before the loan is repaid.
3) Have a budget and the discipline to follow it so you don't run the credit cards up again. (Side note -- if you haven't been there already, check out the Credit Card and Living Below Your Means boards for help with this.)

The interest rate on a 401k loan will probably be around 10% right now, so it could be better than your credit cards. Payments will be withheld from your paychecks, so you don't have to worry about spending the money on something else. The big downside is that if you leave your job, for whatever reason, you must repay the outstanding balance on the loan. If you don't, it will be treated as an early distribution with all the taxes noted above.

Good luck with your plans to get out of debt.

--ptheland
Print the post Back To Top
No. of Recommendations: 1
<<I'm seriously considering an early withdrawl from my 401k to eliminate some serious debt.>>

During your decision making process you need to be aware of the following:

- Not all plans allow in-service withdrawals.
- If the plan does allow in-service withdrawals, 401k plans are not allowed (by law) to distribute 401k dollars prior to age 59 1/2 except for hardship reasons or termination of employment.
- If your plan does allow for hardship distributions, you receive ONLY life-to-date contributions but not any earnings on those contributions.
- If your plan does allow for hardship distributions, you will not be able to contribute to the plan for 12 months.

*Cat
Print the post Back To Top
No. of Recommendations: 0
My recommendation is this.
Don't do it.
Look at your 402k contributions first. Reduct them.
Look at your expenses total, reduce them first.
If you email me back and promise to do the things above then I will give you a better alternative that withdrawal. I have not read the other responses, so maybe thay have told you.
Normally, the really big thing you need when doing debt reduction is attitude changes, spending pattern changes and budgeting.
Also, you will incur a tax liability on top of you debts that you may not be able to pay. Sort of like borrowing at 24% to payoff you debts
Print the post Back To Top
No. of Recommendations: 1
<<I'm seriously considering an early withdrawl from my 401k to eliminate some serious debt. I've investigated budget
re-arranging, paying the debt down over a period of time, but can't wait the 2 years to complete the debt elimination.>>

Why? What's the hurry? Why will working this out over a two year period cause a problem. I'm sure that it took you some time to create the debt. It may take some time to work out also. Don't be in such a hurry. Slow and steady may win this race.

<< This will not be a total withdrawl from my 401k, just a percentage. The question not answered yet is the tax issue. I
know their is a 10% penality cost plus 20% Federal Tax hit.>>

No...no...no...no...no. Your federal tax hit will be at your "marginal" tax rate...whatever that might happen to be. As high as 39.6%. The 20% is just the withholding on the distribution...it has no bearing on the taxes you may eventually pay.

<< I realize the lost investment opportunity to this idea as
well. What's the best way to figure the total tax impact of this debt elimination possibility? I'm just trying to understand if
this is a realistic opition.>>

You'll also remember that your state may also tax (and penalize) your early distribuion. It is very possible that up to 50% of the distribution could be eaten away in taxes and penalties. That, in my opinion, is WAY too big of a price to pay for a quick fix.

The best way...in fact the ONLY way would be to do a mock up of your tax situation and issues. Then take the distrubiton and see what the actual impact will be...on both a federal and state basis combined. You may well be SHOCKED!

Because of the numbers involved, you may want to have some professional help with these computations. If nothing else, some tax preparation software, properly used, can give you the answers. But you should really consider professional guidance.

TMF Taxes
Roy
Print the post Back To Top
No. of Recommendations: 0
<<Withholding rate on distributions (even early ones subject to the 10% penalty) is 20% unless you designate another
higher rate. Generally, you have to elect a higher withholding rate if you want it and you have to elect to have state
taxes withheld. Otherwise, only 20% federal is withheld.>>

Correct.

But the amount withheld from the distribution will have NO BEARING on the actual tax and penalties that will be due on the distribution. Don't be fooled that the worst that will happen is a 20% hit. Nothing could be farther from the truth.

TMF Taxes
Roy
Print the post Back To Top
No. of Recommendations: 0
But the amount withheld from the distribution will have NO BEARING on the actual tax and penalties that will be due on the distribution. Don't be fooled that the worst that will happen is a 20% hit. Nothing could be farther from the truth.

Correct.

The Distribution will be taxed at your marginal rate plus the 10% of distribution penalty. In effect, the minimum tax on the distribution will be 25% in just Federal tax, not counting state tax and a penalty if your state imposes one. Note, not all states impose the tax penalty on early distributions.
Print the post Back To Top
Advertisement