401k and Pension Cash Out

Financial Planning Foolish 401(k)s
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I’m going to bounce an idea out there and I’m all ears on advice.

I’m switching jobs. I have $110k in a 401K and $130k in a pension.

I plan to retire in 20 years. My annual salary is $200k and my skills are up to date so I’m competing in the workplace.

I have 3 kids ages 8, 11, 16. I only have $20k saved for college so far.

Here is what I plan to do:

Rollover the 401K to an Ameritrade Rollover IRA. Invest with a 20-year time horizon.

Cash out the $130k Pension:

Pay off $20,000 in loans
Put $30,000 toward college savings.
Put $40,000 into much needed home repairs
Pay my taxes on the cash out.
Put whatever is left into Apple, Microsoft, Amazon, and Bitcoin

If you see a glaring issue or missed opportunity, would love to hear it.

I do have $200k in equity on my home but do not want to take out a home equity loan for personal reasons (long story, it’s just not an option).

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FYI, I should also note that with my new job I’m receiving 2,000 shares at $34 a share right now with a solid and growing company that is a strong competitor in High Performance computing, AI and the metaverse.

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I plan to retire in 20 years. My annual salary is $200k and my skills are up to date so I’m competing in the workplace.

Okay, so I’m going to assume that since your retirement date is 20 years off, you’re under 59 1/2

Cash out the $130k Pension:

Pay off $20,000 in loans
Put $30,000 toward college savings.
Put $40,000 into much needed home repairs
Pay my taxes on the cash out.
Put whatever is left into Apple, Microsoft, Amazon, and Bitcoin

Well, you have those in the wrong order. Your first item should be “Pay my taxes on the cash out.” Because those taxes are likely to be significantly more than you expect. Since it’s the cash out of an employer pension plan, 20% will be withheld off the top, but that’s not going to be enough to pay the taxes that are due.

Assuming MFJ (since you mentioned kids), even assuming no other income (like stock options/grants vesting or a spouse’s income), your $200k in salary income puts you at the tip-top of the Federal 22% bracket. That means most, if not all, of the $130k in pension will be taxed at 24%, and because you’re under 59 1/2, you will also pay a 10% penalty. So that means that the Federal taxes on the pension will be $44,200. (If you’re filing HOH or Single, the taxes owed will be even higher.) That doesn’t include any state taxes or penalties. So this is what your pension payout will look like after taxes:

Pension $130,000
Withholding $ 26,000
Additional taxes owed $ 18,200
Left after taxes $ 85,800

And if you live someplace like CA, you’ll probably be paying another 8% - 10% in income taxes, plus any penalties that are levied for cashing out the pension early. So that could drop the income after taxes down to around $70k.

Clearly, even if you live in a state that doesn’t charge income taxes, that doesn’t cover the $90k in planned expenses, much less having additional for investments.

My suggestion would be to roll the pension over into an IRA, and start living below your means. (The $20k in loans and $40k in much needed home repairs indicate that you haven’t been living below your means.)

AJ

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Cashing in a pension, prior to 59 1/2, and while having a household income of at least 200k is a pretty terrible idea - especially if you are going to turn around and simply reinvest much of the proceeds.

Better to transfer it to an IRA and pay those loans and home repairs through your existing income.

Put whatever is left into Apple, Microsoft, Amazon, and Bitcoin

One of these things is not like the other…

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Thanks all. Helpful feedback to get me back to earth.

Right now my plan is to rollover all of the 401k and pension minus 40k which I will use for a required immediate home improvement.

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Right now my plan is to rollover all of the 401k and pension minus 40k which I will use for a required immediate home improvement.

Keep in mind that to end up with $40k cash in hand, you will need to actually withdraw $50k, because 20% ($10k) will be withheld for Federal taxes. Then, you will need to come up with another $7k to pay the Federal taxes and penalty that will be due. And be sure that you meet a safe harbor so you don’t end up paying an underpayment penalty.

And that doesn’t include any taxes or penalties that your state will impose.

AJ

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minus 40k which I will use for a required immediate home improvement.

You earn about $16k a month pretax. Could you not wait a few months and accumulate the cash for the home improvement instead of paying at least an extra $5500 in tax penalties?

Are you home improvements so urgent that you are willing to pay an extra $5500 to complete them?

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I don’t get it. You have $200,000 equity in your home but need to cash out part of a pension to pay for much needed home repairs? Refinance and take equity to out to pay for the repairs. The loan is tax deductible. At the least, get a HELOC for the repairs (not tax deductible, but in the long run, cheaper than the taxes/lost earning power by cashing in a pension.

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There is some background which has me not using home equity or a loan. If I bring up the reasons it will be a rabbit hole I don’t want to go down but trust me, they are not options right now.

I have to deal with reality and that is, we need the improvements now, these are not just upgrades, they are needed to get things back in order and nice, and I have to come up with the funds on my own.

I can’t just use my salary over the next few months because I pay for a mortgage, private school, etc… I can’t wait another 6 months to save for it. The repairs need to be done now. So yes, I’ll have to pay a premium to get them done.

Thank you for the warnings and advice though.

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Rvadhv,

I hesitate to suggest because they can be troublesome, but here goes.
If you are still employed at old job, read on. If you left already, ignore this.

401K loan. This requires you to know all the rules before proceeding, check with HR or 401K provider.
Borrow 40K or slightly less from 401K. You then make monthly payments on the loan if they allow this after you leave. What are the rules for moving your 401K after leaving? 30 days, 60 days. End of year 2022? Pay back as much as you can in 1st few months. Once the deadline hits, anything not paid back is a taxable distribution. Rules may make this a non option, but worth doing a look see if it helps you.

Option 2 - short term personal loan. If credit situation makes it worth while. I would only do this if you think you can make the payments to get rid of loan in 2022 or less than a year.

Option 3 - if you have a late model vehicle with a loan, Sell the car, cash. Lease a less expensive model for 2 - 3 years. Then at that time, buy another vehicle that you want. Only works if present car has the value, and knocks off a car loan at the same time.

I would rather take a loss on a car loan and vehicle, before giving retirement money to the taxman.

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Refinance and take equity to out to pay for the repairs. The loan is tax deductible. At the least, get a HELOC for the repairs (not tax deductible, but in the long run, cheaper than the taxes/lost earning power by cashing in a pension.

If used to repair or improve the home, the HELOC interest is deductible, too. The interest on the cash-out portion of the loan is no longer deductible unless it is used to repair or improve the home.

AJ

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401K loan. This requires you to know all the rules before proceeding, check with HR or 401K provider.
Borrow 40K or slightly less from 401K. You then make monthly payments on the loan if they allow this after you leave. What are the rules for moving your 401K after leaving? 30 days, 60 days. End of year 2022? Pay back as much as you can in 1st few months. Once the deadline hits, anything not paid back is a taxable distribution. Rules may make this a non option, but worth doing a look see if it helps you.

The 30/60 day rules on loan payback were changed by the TCJA. All distributions triggered by non-payment of a 401(k) loans after Dec 31, 2017 must provide the ability to pay back the loan until the borrower’s tax return that would show the distribution is due to be filed. Depending on when during the year you leave your job, that’s generally between 4 1/2 and 16 1/2 months after leaving. Because of that requirement, many 401(k) plans now offer the option of continuing to repay the loan over the original timeframe after you leave your employment.

Additionally, I would point out that if the OP rolls their current 401(k) and/or pension payout into their new employer’s 401(k), rather than into an IRA, they could probably get a 401(k) loan from their new employer pretty quickly.

AJ

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Thanks for this additional info, very helpful.

I have a paid-off Lexus in good condition that I’ve been thinking about moving away from. Haven’t even thought about it but with used car prices so high, there is potential here for selling it (estimates are between $10-15k right now) and then leasing. I will consider that.

401k loan as well, I will investigate.

Glad I asked this group - great help. Thanks.

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I mean no disrespect here - as you’ve obviously done well - but you should also consider learning to live below your means (and there is a group here on the Fool dedicated to that). Just saying the obvious here, but you make more than 3.5 times the median income in this country; you have more equity in your house than the average American home is worth; you have a pension (something that is rare these days) and it’s something that has value beyond the dollars it may be worth currently (in terms of lifetime guaranteed income), and yet you find yourself not being able to afford apparently needed home repairs that cost about 20% of your annual income (and an emergency savings account should be able to fund 3 to six months living expenses - and emergencies like this, if you had planned accordingly, and saved appropriately).

Admittedly, I’m biased in favor of preserving retirement benefits at all costs (I work in the retirement plan industry and see many more “failures” to retire comfortably and/or timely that one would think), but you issues seem to be more about your lifestyle than your resources. Just my friendly advice.

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I can’t just use my salary over the next few months because I pay for a mortgage, private school, etc… I can’t wait another 6 months to save for it. The repairs need to be done now. So yes, I’ll have to pay a premium to get them done.

This screams “Living Above My Means”, without even considering the additional information about debt that you wanted to pay off with the pension. Someone who’s making $200k a year should certainly have $40k that they can tap easily, since that’s only 20% of their annual income.

Just sayin’ that mjolah hit the nail on the head with his advice.

AJ

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I was with you until you mentioned Bitcoin, which I consider to be pure speculation and not an investment.

Why do you feel you need to cash out the pension? With your new job, would you not have the income to continue paying off your debts and building up savings? As much as you love your kids, financing their education is whipped cream on top of the ice cream. Paying off your debts and securing your own retirement should be your priority.

But if you can do so without sacrificing retirement savings, that would be my preference. Of course, I’ve never had a pension, so what would do I know.

Fuskie
Who would take a good look at your budget and your new compensation package and try to see if there’s a way to stretch your new cash flow to meet your personal finance needs before sacrificing your pension, but if you decide you do have to use your pension, he would hope you could make a commitment to directing a significant chunk of it into a standard brokerage account, or better yet, a Roth IRA…

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I am with many of the posters that cashing out bad idea. With you stating home equity/cash out refi out of the question, how about an unsecured loan. My brother needed cash quickly to pay cash for a rental and used lightstream loans. He inputted that he was doing home improvements on his home, and they gave him 50k with a week turnaround. Rate was high but his plan was to buy the rental, fix it up and then get a traditional mortgage. Met his short term need and may do the same for you without getting gashed with unnecessary tax bill.

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Thanks for the additional feedback and I don’t disagree. I have been guilty of not saying ‘no’ enough. In the past 2 months I have put in certain guardrails to ensure the spending is capped within a safe zone. I’m not very popular right now but can live with that.

I’m making a long story short but I recently moved back into the home after an 8 month separation which was a financial challenge (my wife doesn’t and has never worked a job that provides income for the family) and the home went into disrepair - so as soon as I moved back, I committed to make the home nice for a new start. Example: my son actually stepped through the floor and there was a hole in the floor in his bedroom, turns out the subfloor was improperly installed 20 years ago. That must be fixed. There are other examples that require immediate attention.

I will consider the unsecured loan route. The cash out was an easy but expensive solution so I am now considering other options.

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“Rollover the 401K to an Ameritrade Rollover IRA.”

Most plans will not allow you to do an IRA rollover until you separate from service or attain age 59.5

“Cash out the $130k Pension”

Do you mean withdraw the cash value of your pension benefit? If so, this will be an expensive action. State tax + Federal tax + 10% early withdrawal plan if you are not yet age 59.5.

The $20k, $30k and $40k whatever’s you need to pay out, you need to figure out how to do this from your $200k income over the months ahead. If you can’t figure out how to do this, then your plan is window dressing and you’ll be back with similar situation in a few years.

I’m retired from the financial planning industry. Used to run into household cash flow issues much like what you’ve described…high income, high debt low FICO score household. The problem here is not cash/excess debt…it’s discipline. No amount of shaming, barking or finger pointing will help. Being a responsible young adult is the best choice

Bruce

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Most plans will not allow you to do an IRA rollover until you separate from service or attain age 59.5

Except the OP said I’m switching jobs. so they will be (probably already have, since the post is 5 months old) separated from service.

AJ

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