Should I Take The Money & Run?

Submitted by Insurance Maze on Thu, 05/08/2008 - 16:08

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

Posted: 08 May 2008 05:18 Post Subject:

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

(you asked :) )

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.

Posted: 08 May 2008 07:22 Post Subject:

Tcope, from your comments it appears you know about as much as the average life agent about tax-favored plans. :) 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. ;)

Posted: 08 May 2008 07:48 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.:lol:


Maze

Posted: 08 May 2008 08:04 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.

Posted: 08 May 2008 08:56 Post Subject:

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?

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



Yes, you did.

Maze

Posted: 09 May 2008 12:00 Post Subject:

Fishman is right on target:

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!! :cry:

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! :cry:

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.

InsTeacher 8)

Posted: 09 May 2008 11:45 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

Posted: 09 May 2008 12:11 Post Subject:

What advice would you give your client?

Grab his butt at tax time, because he is going to owe a bundle!!!!!!!!!!!!

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: )

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)...

Posted: 09 May 2008 02:26 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.

Posted: 09 May 2008 04:55 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. :cry:

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. :shock:

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

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.

InsTeacher 8)

Posted: 09 May 2008 05:01 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.



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

Posted: 09 May 2008 05:21 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

Posted: 09 May 2008 05:39 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.

Posted: 09 May 2008 05:50 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

Posted: 09 May 2008 08:24 Post Subject:

OK, the only plans that accept "transferred" dollars are either to transfer into the new employer's 401k (if allowed by the plan, and not all plans do allow this) or into an IRA; self-directed or traditional. No non-qualified annuity will qualify for transfer dollars and keep the tax-structure of the 401k in place. Now, if the participant wants to roll the funds into anything else, remember- it's their money and they can do whatever they want with it. Again, just remember that they are gonna pay the piper with penalties prior to age 59 1/2 plus taxation on the entire amount withdrawn.

The only tax-qualified annuity that will accept transferred dollars, if I'm right (and I'll be the first to admit that I certainly don't know everything by any stretch of the imagination), would be a 403b tax-sheltered annuity. This, under current rule (they change in 2009) is only available for employers that file under sections 501 (c) (3) of the Internal Revenue Code. This is for non-profit employers only.

If anyone has anything further (tcope???) please respond!

InsTeacher 8)

Posted: 09 May 2008 08:59 Post Subject:

No non-qualified annuity will qualify for transfer dollars and keep the tax-structure of the 401k in place.



Agreed.

The only tax-qualified annuity that will accept transferred dollars, if I'm right (and I'll be the first to admit that I certainly don't know everything by any stretch of the imagination), would be a 403b tax-sheltered annuity.



No, Teach. Most traditional tax deferred annuites or equity indexed annuities can be qualified plans and will accept qualified rollovers.

Maze

Posted: 12 May 2008 02:06 Post Subject:

No, Teach. Most traditional tax deferred annuites or equity indexed annuities can be qualified plans and will accept qualified rollovers.



But only if they're installed within a qualified plan, agreed? Individual non-tax qualified annuities aren't within this structure.

InsTeacher 8)

Posted: 12 May 2008 02:15 Post Subject: 401(k)

Not all plans allow for withdrawls.... check the plan documents. It's up to the employer and how he/she set the plan up.

Posted: 12 May 2008 02:43 Post Subject: insurance

Ok...........yep, alittle 'insurance stupid', again. IRA VS. 401 (K). Whats' the 'benefit' difference? What amount do you need to start EACH one?

Posted: 12 May 2008 10:16 Post Subject:

I don't think you need a certain amount to 'start' either...But there is (I think) a limit to how much you can put into both per year...(I contribute plenty, but husband handles all of that ! :roll: boring money saving/investing stuff :wink: )

Posted: 12 May 2008 10:59 Post Subject: insurance

Do you ( any one in general) think it's a good idea to start a 401 (K) instead of 'rugular' Life Insurance? Are the benefits the same ( ie..Cash Value, death Benefits, etc?) Can I put it in BOTH mine and my son's name ( Godforbid anything happens to him).

Posted: 12 May 2008 11:08 Post Subject:

Do you ( any one in general) think it's a good idea to start a 401 (K)

I personally think that most 401k's are an excellent way to put money away...

instead of 'rugular' Life Insurance?

NO, you should have atleast some life policy....

Are the benefits the same ( ie..Cash Value, death Benefits, etc?)

No 401k's are not a life policy they are an investment/savings plan...no death benefit except they are paid to a beneficiary, but only what is in the account, not a death benefit persay...

Can I put it in BOTH mine and my son's name ( Godforbid anything happens to him).

You can make him the beneficiary of your 401k....meaning it goes to him if you die...kind of like your savings account would...think of it like that...NOT as a life policy.

Posted: 12 May 2008 04:36 Post Subject:

But only if they're installed within a qualified plan, agreed? Individual non-tax qualified annuities aren't within this structure.



Yes, InsTeacher, but I think most people misunderstand annuities and how they work and this is why they usually get a bad reputation.

Non-Qualified Annuity
This is a "tax-deferred" annuity that is purchased with "after-tax" dollars and would not be part of a qualified retirement plan, like an IRA.

Qualified Annuity
This type of "tax-deferred" annuity would be purchased with "before-tax" dollars and could be used to fund an IRA. This would be an appropriate vehicle in which to transfer 401(k) monies left with a previous employer.
This would be an "individual" purchase, not part of any company sponsored retirement plan. So, in the senario we have been using, the employee would have an individual IRA containing his old 401(k) money, then he would begin making contributions to the 401(k) plan at his new place of employment.

Tax-Sheltered Annuity
This type of "tax-deferred" annuity is only available to employees of schools, non-profit hospitals, and other tax-exempt organizations, known as a 403(b) plan.

There are many variations of annuities, like "single premium" or "flexible premium" and within these payment arrangements, they could be "fixed", "variable", "deferred" or "immediate". Many companies that convert a retiring employee's retirement account to income, buy an "annuity".

Ok...........yep, alittle 'insurance stupid', again. IRA VS. 401 (K). Whats' the 'benefit' difference? What amount do you need to start EACH one?



The first thing to do is separate the word "insurance" from "IRA". Insurance should never be purchased as an "investment" or for cash accumulation only.

Most people think of "IRA" as "Individual Retirement Account", and it is, but it also "Individual Retirement Arrangement", which I think is clearer.

A person can set up an IRA with a brokerage firm, a bank or other financial institultion, or with an insurance company (annuity).

The amount needed to start an "IRA" can range from "0" to thousands of dollars, depending the "Arrangement". Most banks have "minimum" deposits to open accounts, like IRAs. IRAs funded by the purchase of an annuity may require a minimum, like "$50, more if it is a single premium.
This is where a good financial advisor is very important. There are so many different ways to properly prepare for a comfortable retirement that most of us just need professional help.

Do you ( any one in general) think it's a good idea to start a 401 (K) instead of 'rugular' Life Insurance? Are the benefits the same ( ie..Cash Value, death Benefits, etc?) Can I put it in BOTH mine and my son's name ( Godforbid anything happens to him).



Again, please don't confuse "investments" with "life insurance". They are two very distinct parts of your financial plan. 401(k) plans are normally sponsored by an employer, even though they can be established by a sole proprietor small business.

You could set up an IRA and contribute up to $5,000 or 100% of your taxable compensation (whichever is smaller).

Before you decide, I think you should get some professional advice.

Maze

Posted: 13 May 2008 10:36 Post Subject: insurance

I appriciate ALL of the advice, on this issue. Thanks SOOO much!! I know people with BOTH an IRA and 401 (K). I know some with just one OR the other. (Here comes the 'stupidity again..) I guess I din't realize a 401 (K) was some kind of 'investment'. MMMM.

Posted: 13 May 2008 11:12 Post Subject:

Here comes the 'stupidity again..)

In the words of the Great Forrest Gump, ''Stupid is as Stupid does''...no (genuine) questions are stupid.. :wink:

Posted: 13 May 2008 11:25 Post Subject: insurance

I LIKE Forrest Gump, too! FYI.......kinda funny you said something about Forrest Gump. In 'our' community paper, I saw a picture of a soldier, who returned from Iraq. Guess who the picture was?!...........I can't remember his REAL name, but, it was the boy who played Forrest Gump, at the beginning of the movie. BOY...that was exciting to see!! Anyway...back to the 'insurance thing'.....................I suppose in each Insurance 'catagory', there are 'sub-catagories'. ....can get confusing sometimes.

Posted: 13 May 2008 08:16 Post Subject:

Yes, insurance can be very complex and, if for no other reason, I just can't imagine buying it over the internet, like a toaster or something.

Many people get in difficult situations because they know just enough about insurance to be dangerous to themselves and their families or business.

That's why we have insurance agents.

Maze

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