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First, our tax situation: Married, filing jointly, with 4 kids. (Last year, under similar circumstances, we qualified for various credits allowing us a significant 'refund' even though we paid no taxes. Our AGI was under $25K, and I expect it to be no more than $30K this year.)

I have about $5100 in a Simple IRA (at Vanguard) from my last job. My first contribution was made more than 2 years ago. (I include this because my research tells me that the date of first contribution affects the penalty).

I had been planning to roll it over into an existing Roth IRA at TIAA-CREF. They told me the conversion will require me to pay taxes on the amount as regular income, but there is no penalty.

But I also have about $5200 of debt on one of my credit cards. It occurred to me to instead take an early withdrawal and use the proceeds to pay off the credit card.

I now that if I do that, I have to pay taxes AND a penalty, but how much is the penalty?

If the penalty is small, it might be less than the interest I'll end up paying on the credit card.

I'm no tax expert, so I very much welcome any suggestions (and/or criticisms) you folks have.
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I have about $5100 in a Simple IRA (at Vanguard) from my last job. My first contribution was made more than 2 years ago. (I include this because my research tells me that the date of first contribution affects the penalty).

I had been planning to roll it over into an existing Roth IRA at TIAA-CREF. They told me the conversion will require me to pay taxes on the amount as regular income, but there is no penalty.

But I also have about $5200 of debt on one of my credit cards. It occurred to me to instead take an early withdrawal and use the proceeds to pay off the credit card.

I now that if I do that, I have to pay taxes AND a penalty, but how much is the penalty?

If the penalty is small, it might be less than the interest I'll end up paying on the credit card.


The penalty is 10% of the gross, making the total tax 25%. I didn't do the math, but t his will leave you less than $4,000 to apply to your $5,200 debt.

I wouldn't take the premature distribution for this purpose.

Phil
Rule Your Retirement Home Fool
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"I had been planning to roll it over into an existing Roth IRA at TIAA-CREF. They told me the conversion will require me to pay taxes on the amount as regular income, but there is no penalty."

There may be a confusion of terms here. There is no tax or penalty for a direct rollover from SIMPLE to traditional IRA, when you've held that particular SIMPLE IRA for at least 2 years. However, you use the word 'conversion', which the custodian may have heard to be a Roth conversion, for which there would be no penalty yet the conversion would be includable by you as ordinary income for that year.

"But I also have about $5200 of debt on one of my credit cards. It occurred to me to instead take an early withdrawal and use the proceeds to pay off the credit card."

Yes, you could do that. But there would be a 10% penalty (assuming you are not yet 59.5) and it would be reportable as income. But equally important, you'd be robbing from your retirement piggy bank to pay for current debt. Yes, it is good not to be carrying debt...particularly debt of the high interest type. But you'd be better served to gradually pay off the debt and NOT to incur any more, while leaving your retirement piggy bank alone.

BruceM
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But I also have about $5200 of debt on one of my credit cards. It occurred to me to instead take an early withdrawal and use the proceeds to pay off the credit card.

I now that if I do that, I have to pay taxes AND a penalty, but how much is the penalty?

If the penalty is small, it might be less than the interest I'll end up paying on the credit card.


The penalty is 10%. You end up paying it even if your total income, including the IRA withdrawal, is low enough that you don't have a federal income tax liability.

You also need to be aware that the proposed $5100 of IRA withdrawal is not earned income. Depending on how the numbers shake out, it could have a negative impact on any EIC you might qualify for.

Is there a reason you haven't considered, or have rejected, the idea of either leaving the Simple IRA in place or rolling it to a traditional IRA for no tax impact?

Patzer
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Yes, you could do that. But there would be a 10% penalty (assuming you are not yet 59.5) and it would be reportable as income.

There is a 10% federal penalty. Your state may also assess a penalty.
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Depending on how the numbers shake out, it could have a negative impact on any EIC you might qualify for.

For TY2010, I used "H&R Block At Home" software to calculate my taxes. I realize that tax laws change from one year to the next, but I wonder if I could just re-calculate last year's taxes using the rollover vs. withdrawal scenarios?

Is there a reason you haven't considered, or have rejected, the idea of either leaving the Simple IRA in place or rolling it to a traditional IRA for no tax impact?

I have a reason, but it's emotional, not logical. The idea of tax-free growth in the Roth appeals to me. The fact that I expect my income this year to be very low makes now seem like the ideal time to do this. Superficially, it won't seem like any money out of my pocket, since EIC and child tax credits are so big, doing a Roth Rollover (tax only) or taking it as a distribution (tax + penalty) will most likely only reduce the (relatively massive) 'refund' I'll get.

BTW, I'm expecting to graduate in December, and I've already started looking for a full-time job. I hope and expect my income next sear to be at least a 3x multiple over this year's income.
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For TY2010, I used "H&R Block At Home" software to calculate my taxes. I realize that tax laws change from one year to the next, but I wonder if I could just re-calculate last year's taxes using the rollover vs. withdrawal scenarios?

It won't be precise, but if this year is similar to last year that would give you a ball park estimate. Of course, if Congress makes significant changes all bets are off. It's still a little early to predict what foolishness Congress will add to the tax code for 2011.

The fact that I expect my income this year to be very low makes now seem like the ideal time to do this. Superficially, it won't seem like any money out of my pocket, since EIC and child tax credits are so big, doing a Roth Rollover (tax only) or taking it as a distribution (tax + penalty) will most likely only reduce the (relatively massive) 'refund' I'll get.

Absent a major impact on credits, and assuming sufficient financial resources to cover the tax, this would be the year to do the Roth conversion. The conversion has no penalty, so you're only looking at the change in taxable income and any impact on EIC and any other low income credits you might get.

I hope and expect my income next sear to be at least a 3x multiple over this year's income.

With that expectation, I wouldn't dream of liquidating retirement assets to pay off the credit card. That $5.2K balance will become much more manageable on the increased income you expect.

Patzer
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Yes, you could do that. But there would be a 10% penalty (assuming you are not yet 59.5) and it would be reportable as income.

There is a 10% federal penalty. Your state may also assess a penalty.



are there any exceptions?

if the funds are used to pay medical bills or education expenses?


(i seem to recall Steven had some recent big medical bills and is going to school)
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With that expectation, I wouldn't dream of liquidating retirement assets to pay off the credit card. That $5.2K balance will become much more manageable on the increased income you expect.

Good point.

Of course, my hope is based on my ability to get a job in my field (ideally in metro Detroit) after I graduate in December. I'm 46, with more than a decade of experience in my field, and I'll be competing against other new graduates who are half my age.

Still, I remain optimistic!
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are there any exceptions?

if the funds are used to pay medical bills or education expenses?


(i seem to recall Steven had some recent big medical bills and is going to school)


There are exceptions, and referencing Publication 590 to see if any apply would be a good idea.
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are there any exceptions?

if the funds are used to pay medical bills or education expenses?


(i seem to recall Steven had some recent big medical bills and is going to school)


The OP made no specific reference to conditions that might exempt him from the 10% penalty. But for completeness, other than attaining age 59.5, the IRS recognizes 9 potential exceptions to the 10% early withdrawal penalty on the untaxed portion of the withdrawal from a traditional, SEP, or SIMPLE (after 2 years) IRA:

1. Paying for qualified education expenses in the year they are incurred (or within 3 months of the following year)

2. Paying for qualifying medical expenses that are in excess of 7.5% of AGI

3. As part of a series of substantially equal payments that are withdrawn annually for the later of 5 years or to age 59.5 (aka a '72t')

4. Beneficiary withdrawals due to your death

5. Withdrawals after you've become disabled and unable to work.

6. Up to $10,000 of pretax withdrawals over one's lifetime to pruchase a home when one has not been a homeowner for at least the previous 2 years.

7. Withdrawals as a result of a Qualified Domestic Relations Order from a state divorce decree.

8. Withdrawals to pay for health insurance premiunms if withdrawal is within the year of unemloyment or the next year and you have collected unemployment insurance for a minimum of 12 consecutive weeks

9. Withdrawls made at the point, or later, that a miliary reservist is called to duty for at least 180 days.

As previously noted, state income tax rules may not recognize some or many of these 10% exceptions.

BruceM
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(i seem to recall Steven had some recent big medical bills and is going to school)

No recent big medical bills. I am in school, but I expect to graduate in December.

After reading through the messages in this thread, I've decided to roll it over into an IRA or Roth IRA. I just haven't decided which yet. That's a topic for another thread.
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After reading through the messages in this thread, I've decided to roll it over into an IRA or Roth IRA. I just haven't decided which yet.


if your income (Tax) is low while going to school.. Roth could be a good idea

and some of each is possibility (i'm pretty sure)
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