Should I Take The Money & Run?

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PostPosted: Thu May 08, 2008 4:08 pm   Post subject: Should I Take The Money & Run?  

Let's suppose a client came into your office and advised you that he/she had $150,000 in 401(k) funds which he/she left with a previous employer.

The client further explained to you that these funds could not be left with the previous employer, but had to be moved.



The client is thinking about just taking the money to invest in his own insurance agency, but just can't decide what to do. The client is 45 years old.



What advice would you give your client?



Maze



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PostPosted: Thu May 08, 2008 5:18 pm   Post subject:   

Seek the advise from someone who knows more about the issue then me.



(you asked Smile )



I guess the question really is if the person expects to be able to return a profit by the time they retire. Also, if the person takes the money they will pay a huge penalty (I think 20%). They can roll it over into another retirement account within 45 (I think it's 45) days and not suffer any penalty.

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PostPosted: Thu May 08, 2008 7:22 pm   Post subject:   

Tcope, from your comments it appears you know about as much as the average life agent about tax-favored plans. Smile At least according to Dateline NBC.



Seriously though, taking the money and running is not a great idea. The IRS penalty for withdrawal before age 59 1/2 is 10%, but that's on top of whatever tax bracket you're in, since it'll all be taxable income if he takes it all out, so now we're talking 30-50% of his 150,000 going to Uncle Sam.



Boy, have I got an IRA annuity for this hypothetical customer. I won't be like the (insert name of financial advisory firm) guy and blow a bunch of smoke about 12-18% returns in mutual funds or exquity indexed products. Instead I'll guarantee him that he'll have more money every morning when he wakes up than he did when he went to bed.



When he asks about all those sneaky hidden fees he's heard these annuity things are full of, I'll tell him this product has no hidden fees, it has no overt fees, no fees period.



By the time he's 59 1/2 he'll have at least $230,000 (it's guaranteed) and probably more than $250,000 (and that's just if he doesn't make any additional contributions, which he's free to do) At this point it'll all be free and clear of any IRS or company penalty.



Then I'd suggest that he take the original $150,000 to invest in an insurance agency if he still wants to so that when he loses money on that there will still be 100,000 growing in his IRA.



But I'd strongly advise against that, as we all know, insurance agents do make any money. Wink

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PostPosted: Thu May 08, 2008 7:48 pm   Post subject:   

Would you not even discuss with your client the possibility of transferring the 401(k) funds from the current plan administrator to the plan administrator of the current employer's retirement plan?



Just a thought from an ole' insurance agent.Laughing





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PostPosted: Thu May 08, 2008 8:04 pm   Post subject:   

Well, maybe, but if that was an option he would probably have done it without consulting me. Most of the cases like this that I encounter are people who are looking for a way to "stop the bleeding" of their 401(k) so another 401(k) is usually not an option.



Now, a younger person looking for advice on how best to save for retirement, the first thing I'd say is max out your contributions to the 401(K) if you have one, especially if your employer will match contributions because I sure can't match contributions to the IRA for you. Then if you still want to put more away we'll talk about a non-qualified annuity.



No disrepect to mutual funds and stock market investments but I don't want to have to hope that my retirement fund is up when I'm ready to retire. I want to know how much I'll have at age 65, I want gaurantees.



Oh, and of course I meant to say insurance agents don't make any money. Blew a joke dang it.

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PostPosted: Thu May 08, 2008 8:56 pm   Post subject:   

Quote:
Well, maybe, but if that was an option he would probably have done it without consulting me.




You would be absolutely amazed at the number of HR people who know absolutely nothing about their own company's retirement plan.



When an employee decides to leave the company, everyone seems to be totally through with that employee and most, I have found, don't seem to be interested in spending their time in giving an ex-employee advice of any kind.



If no one advises that employee, then how does he/she know?



Quote:
Oh, and of course I meant to say insurance agents don't make any money. Blew a joke dang it.




Yes, you did.



Maze


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PostPosted: Fri May 09, 2008 12:00 am   Post subject:   

Fishman is right on target:



Quote:
Seriously though, taking the money and running is not a great idea. The IRS penalty for withdrawal before age 59 1/2 is 10%, but that's on top of whatever tax bracket you're in, since it'll all be taxable income if he takes it all out, so now we're talking 30-50% of his 150,000 going to Uncle Sam.




Also, don't forget the state tax bite in addition to the federal whack- that could easily add from 5-10% additional taxation. NOT A GOOD IDEA! Look at the math:



10% federal penalty on the premature (<59 1/2) = $15,000

40% nominal (likely) federal tax whack: 60,000

5% state (average) tax whack: 7,500

Total penalties and taxation: $82,500



The 401(k) holder would lose, according to these calculations (and trust me- they're really close to accurate) 55%!



BAD BAD BAD IDEA!! Crying or Very sad



If the new plan does not accept "transferred dollars" or they would have to wait for (typically) one year to get into the new plan, that "strands" the

401(k) dollars in the old account. AGAIN- BAD BAD BAD. You cannot contribute anymore to that old plan either since you aren't an employee! Crying or Very sad



Get the bucks into something that will actually work for you! Nothing personal about this Fishman, but I always recommend someone close to you in terms of geography to transfer the funds to.



Hope this helps with the clarification.



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PostPosted: Fri May 09, 2008 11:45 am   Post subject:   

Ok, Teach and Fishman, but we have forgotten an important part of this senario. This person wants to start an insurance agency and he needs "seed" money to get the business up and running.



Can he borrow money from his 401(k) and pay himself back?



Also, if this person has never owned a home and wishes to run his business out of a part of a new home purchase, can he get the money out of the 401(k) without penalty?



Maze



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PostPosted: Fri May 09, 2008 12:11 pm   Post subject:   

Quote:
What advice would you give your client?
Grab his butt at tax time, because he is going to owe a bundle!!!!!!!!!!!!
Quote:
Can he borrow money from his 401(k) and pay himself back?
yep if his plan allows it (after he transfer it to his new employer Wink )
Quote:
Also, if this person has never owned a home and wishes to run his business out of a part of a new home purchase, can he get the money out of the 401(k) without penalty?
yes, and no, he still has to pay taxes and there are still fees...(in the ones I've seen)...


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PostPosted: Fri May 09, 2008 2:26 pm   Post subject:   

I the person buys a home and it's his primary residence then he probably qualifies for a hardship withdrawal and would not pay the early withdrawal penalty but as Lori mentioned, he would owe income tax on the money. When I did this, I withdrew only the amount I needed to close on the house. Using the entire $150k would not be a smart move IMHO. 401k money should be used for retirement... that is what it's there for.

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PostPosted: Fri May 09, 2008 4:55 pm   Post subject:   

Loans out of 401(k) plans may or may not be a bad idea.



First of all, if you are allowed to borrow out of your 401(k), you will be required to pay back the loan within (normally) 5 years. Loans taken for a primary residence will extend that payback period. The good news is that loans are not withdrawals, and therefore not subject to premature distribution penalties if you're <59 1/2. On the other hand, if you don't pay back the loan within the prescribed period, it will then be considered a premature distribution and whacked with taxes and penalties. You can normally borrow up to 50% of your vested account balance to a maximum of $50,000. If you have previous loans out, that number changes.



Finally, if you terminate your employment, and the loan hasn't been repaid, it will now be considered a premature distribution as well. Most plans require that the loan be repaid within 60 days of termination or you'll pay the piper. Crying or Very sad



Also consider the "time value of money" and the fact that you will be repaying the loan with after-tax dollars. You have borrowed money from a fund that enjoys tax-deferred growth and the dollars that went into the fund were pre-tax- huge advantages. If you're in a 30% tax bracket, for every $300 you borrow, it will cost you roughly $400 in loan repayments.

Plus, you will lose all of the gain those dollars were earning while they were still in the plan. Shocked



I consider loans from retirement plans an avenue of last resort. I fully agree with tcope:



Quote:
401k money should be used for retirement... that is what it's there for.


To start an insurance agency with these funds will not qualify for a hardship withdrawal, by the way.



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PostPosted: Fri May 09, 2008 5:01 pm   Post subject:   

Quote:
I the person buys a home and it's his primary residence then he probably qualifies for a hardship withdrawal and would not pay the early withdrawal penalty but as Lori mentioned, he would owe income tax on the money.




First of all, I want to say right up front, borrowing money from a 401(k) plan is not the best idea in the world, but . . .



If the choice comes between taking a "hardship withdrawal" and making a "loan", take the loan.



A person can borrow up to 50% or $50,000 (whichever is less) of vested funds and have up to 5 years to repay the loan. If the loan is for the purchase of a "first home" the re-payment period can be longer.



As long as the loan is being re-paid, there are no early withdrawal penalties and the loan amount does not have to be declared as income for state and federal income tax purposes. If the loan is not repaid then it's income and an early withdrawal.



If a person chooses a "hardship withdrawal" (before 59 1/2), then it's an early withdrawal and the 10% withdrawal penalty comes into play and the amount must be declared as income for tax purposes.



I hope InsTeacher will get back in on this one.



We really still haven't come up with an appropriate response to this client's concerns.



Maze


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PostPosted: Fri May 09, 2008 5:21 pm   Post subject:   

I know we are not supposed to post to our own posts, but Teach we were evidently working on this at the same time. We say almost the same thing.



How about that?



If this person took a temporary pay cut to change employers, would that qualify as a hardship?



Maze



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PostPosted: Fri May 09, 2008 5:39 pm   Post subject:   

"The following items are considered by the IRS as acceptable reasons for a hardship withdrawal:



Un-reimbursed medical expenses for you, your spouse, or dependents.



Purchase of an employee's principal residence.



Payment of college tuition and related educational costs such as room and board for the next 12 months for you, your spouse, dependents, or children who are no longer dependents.



Payments necessary to prevent eviction of you from your home, or foreclosure on the mortgage of your principal residence.



For funeral expenses and repair of a primary residence. "



Keep in mind also that the employer is not required to allow this type of withdrawal. It's just allowed by the IRS.

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PostPosted: Fri May 09, 2008 5:50 pm   Post subject:   

OK, so do we all agree that when we advise our client, we can tell him that he has several options?



OPTION #1: If allowed, move the 401(k) funds to his new employer's 401(k) plan.



OPTION #2: Rollover the 401(k) funds into another qualified annuity(IRA).



OPTION #3: If the reduction in income has caused him to default on house payments and he runs the risk of foreclosure, he may qualify for a "hardship withdrawal".



OPTION #4: He may be able to borrow up to $50,000, without penalty, if the loan is repaid.



If the client decides to do a rollover, would you recommend a qualfied indexed annuity, a traditional deferred qualified annuity, a 401(k) plan which can be set up under his insurance agency or something else?



Maze



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