Cash out the 401k?

[DrK1992]

I am 43 yrs old, and after 11 years of investing, my 401k is worth $600k, which is 2x what I have put into it. Our debt load has us paying an avg of about 9% on an amount almost equal to my 401k value. I am in the highest tax bracket and Obama is about to make that much worse next year. Everything I am reading about the instability of the US Banking system and deflation, etc.. has me worried about debt and I want out of all of it. Is it too crazy to cash the 401k out, pay the 10% penalty and the taxes at todays tax rate and make myself debt free? I could start all over on the savings part of it into Roth IRA's and not lose all that money to interest on debt. Plus I doubled my money in the market, why not use it to some advantage before the higher taxes and the death taxes take it all away? Advice?

[pochax]

I am 43 yrs old, and after 11 years of investing, my 401k is worth $600k, which is 2x what I have put into it. Our debt load has us paying an avg of about 9% on an amount almost equal to my 401k value.

Welcome, DrK, to the forum! what makes up your substantial debt (~$500k based on your comments)? mortgage? cars? CC debt? that may be helpful in sorting your situation out.
also, please explain how you were able to put in $300k into 401k in 11 yrs. At <50 yrs of age the law has set the contribution cap to $16500 for 2010 and that has not been so high over the last 11 yrs. even if you put in $150k yourself, are you saying you got a 100% employer match?

I am in the highest tax bracket and Obama is about to make that much worse next year.
Everything I am reading about the instability of the US Banking system and deflation, etc.. has me worried about debt and I want out of all of it. Is it too crazy to cash the 401k out, pay the 10% penalty and the taxes at todays tax rate and make myself debt free?

Unless you are facing bankruptcy or foreclosure, i would not recommend cashing out your 401k. if you are in the highest tax bracket (35%) + penalty (10%) are you willing to pay 45% of $600k? that doesn't even take out your debt based on what you said above, does it?

I could start all over on the savings part of it into Roth IRA's and not lose all that money to interest on debt.

How do you do this if you are in the highest tax bracket? i am not even in the highest tax bracket but no longer am eligible to contribute to a Roth (max AGI is ~$160k annual income for married filing jointly to contribute).

Plus I doubled my money in the market, why not use it to some advantage before the higher taxes and the death taxes take it all away? Advice?

If you are only 43, when do you plan to retire? your 401k cannot be taken out prior to 59.5 yrs without penalty except under special circumstances. how do you know what the tax brackets/rates will be then? you are acting too much on current circumstances that may or may not have relevance to the distant future. i recommend to sit tight on your 401k. if you want to get rid of your debt (which i do endorse), a better option would be to stop contributing to your 401k and use that money to pay down your debt. if most of your debt is mortgage, consider downsizing. dave ramsey suggests never to pay more on a home than 25% of your take home pay on a 15-year fixed rate mortgage.

[KrozFan]

Yeah, I'm with pochax, I wouldn't cash out. First I'd stop investing to pay off debts. If you're investing about 30k/year that's a lot of debt to pay down. I'm also assuming you make quite a bit of money, so the 30k you're not investing added to extra money you throw at debt because you're serious about getting out of debt would take care of it rather quickly. Are there things you can cut out of your life? I would rather stop eating out and sell a fancy car if you have one rather than pay your tax rate +10% to get out of the 401(k).

Also, if you're worried about the economy make sure you're on a fixed rate mortgage. Variable rates will only go up. What's your mortgage rate at now, would it be worth refinancing?

[DrK1992]

I am technically self employed, in an LLC with 84 other doctors. The way we set it up is we can match ourselves 100%, so yes I have been matched 100%....by myself. This year I can do $33k. My mortgage is fixed at 15yrs 5% and I'm in the 5th year of that. The debt I want rid of is credit card debt/unsecured debt (about $80k) and mortgage. I don't have a fancy car ('07 Camry). I am worried about global financial collapse and would rather have no debts to deal with. From what I've read, our taxes will never be as low as they are now and the estate (death) tax will incrementally increase to the point where the government gets most of it when I die, not my kids. I've also read that one way the government is planning on paying down the out of control debt is by hitting eveyones 401k's, by forcing everyone to put a certain percentage of their 401k into government bonds. That way the government gets to use the cash out of our 401k's to pay their debt and then when we die, they basically get the rest. I just want to have the chance to use what's mine for my own good before it all gets taken away. My reasoning was that today's tax rate +the 10% penalty will still net me 49.6% of my total, and that's about exactly how much of my $600k I have actually put in. So net no loss. Is there any merit to my concerns or have I been reading the wrong books/blogs?

[clydewolf]

Drk1992,

Welcome to the forum.

One major obstacle to your plan to cash out your 401k, you must leave your current employer before you can get your money out of the 401k plan. I suggest you read the Summary Plan Description for your employer's 401k plan. You can see this on line or get a copy from the 401k plan administrator.

An idea to consider may be to stop making contributions to the 401k, or at least limit your contributions to the plan contributing enough to capture the employer matching contribution. Then apply the 401k contribution reduction amount to your debts. But note reducing your contribution to the 401k plan will increase your income tax withholding and your tax due on your form 1040.

If this is your own corporation or some type of partnership, you may be able to terminate the 401k plan and then transfer the money to an IRA. You would need to consider how this would affect your employees or your partners. Once the money is in the IRA, you can take distributions, paying the tax and the 10% penalty. !0% penalty vs 9% interest?

It is rarely a good idea to pre-pay your taxes on such a large amount of money.

You should also evaluate why you have such a large debt. Find ways to keep the debt from growing. Perhaps you could sell some items you have acquired and use the proceeds to pay down your debt.

I just noticed your follow-up post -

I mentioned earlier to stop or limit your 401k contributions. If you made no 401k contribution this year, there would be $21,450 (33,000*35%=11,500) you could apply to your debts.

Do not worry about future tax rates. Remember that the rest of us will be facing those rates too. If you trust God, you know things will workout for the best.

Do you have adequatae life insurance? Your family and children can benefit from being the beneficiary of your life insurance.

Right now, you can gift to your children up to $13,000 without any tax or filing consequence. Your spouse can do the same.

You should find a fee only financial advisor and discuss your situation with them, and formulate a plan and implement that plan.

[KrozFan]

Is there any merit to my concerns or have I been reading the wrong books/blogs?

Yeah, you're reading the wrong blogs. You need to chill. "Global Finaicial Collapse"? Take a breath, relax, turn off the CNN. I would not take money out of the 401(k). You should be able to clear up 80k in two years if you work hard, especially if you stop putting money into the 401(k).

If you're really really worried downsize the house, assuming you aren't upside down in it, and take any equity in it to buy a smaller house, with a smaller payment, and take the money you're saving in payments to throw at the debt.

There are a lot of sacrafices that you can make that will end up costing less than the 300k hit you expect to take by cashing out the 401(k)

[pochax]

Thanks, DrK, for the clarifications...i will actually start with your last question then work through:

Is there any merit to my concerns or have I been reading the wrong books/blogs?

As with most information, much of the facts are right, but the conclusions have potential errors. much of what you are basing your decision on is conjecture, prediction...so it MIGHT come true, but it also might not come true. the likelihood of which varies depending on who you talk to. i am only one opinion...i read the daily news and try to keep up with economic conditions and updates that would affect my family's financial situation, but i am by no means an "expert" when it comes to these things. having said that, i have been studying/following this stuff long enough to know that even the so-called "experts" often have no clue what they're talking about either.

I am technically self employed, in an LLC with 84 other doctors. The way we set it up is we can match ourselves 100%, so yes I have been matched 100%....by myself. This year I can do $33k.

Thanks for clarifying - no i understand how you got the hefty sum you currently have - congratulations on your diligence at saving.

My mortgage is fixed at 15yrs 5% and I'm in the 5th year of that.

so it sounds like the mortgage is ~$400-450k? if you are staying for the long haul AND you have equity, you may want to consider refinancing to even a lower rate (sub-4%) with the current mortgage rate market.

The debt I want rid of is credit card debt/unsecured debt (about $80k) and mortgage.

i recommend prioritizing getting rid of the CC/unsecured debt. the other 800-lb gorilla is what led to that $80k debt and whether it will continue once you pay it off. Paying it off is merely a touch-up job if it is likely that it will build up again. i am not against credit cards like some on this forum, but i am against paying needless interest so i advocate paying off all CC balances every month and accrue any rewards you can get.

I am worried about global financial collapse and would rather have no debts to deal with.

Here is where media hype probably has gotten to you and others and there will be differing opinions. personally i believe "collapse" is unlikely and if it DOES occur, personal finances will likely be the least of our worries (rioting, pillaging, all out war, nuclear holocaust, alien insurrection, etc.)....then again, this being a christian forum, i also believe that Christ can come any time and we ought to be ready...and unlikely to be able to take our homes or 401ks with us.

From what I've read, our taxes will never be as low as they are now

I give this a probably true. With the mounting entitlement programs (SS and Medicare) i agree that it is likely taxes will go up. but you did not answer the question on how you will get the money into a Roth. i also throw it there if the govt would be so unkind as to force usage of your 401k to buy govt bonds, why also would they not tax your Roth? Nothing is safe if you are a conspiracy theorist.

and the estate (death) tax will incrementally increase to the point where the government gets most of it when I die, not my kids.

i'm sure you've already discussed your estate planning with an specializing attorney but in case you haven't, they have trusts set up to minimize these consequences. also, you are exempt for the first $1M and likely Congress will standardize this to inflation. If not, i am sure there will be other ways to avoid. If you are married, you can set up an A/B trust and double the exemption. you can give up to the gift-tax exclusion and slowly pay down assets to your heirs as well. Speak with an estate planning attorney and i think the death tax is the least of your worries. So far you have not told us you have other assets that net you above $1M in net worth so the death tax doesn't even apply to you yet. (If you have millions/billions stashed away that you haven't mentioned, then i would wrong...but you haven't mentioned it yet).

I've also read that one way the government is planning on paying down the out of control debt is by hitting eveyones 401k's, by forcing everyone to put a certain percentage of their 401k into government bonds. That way the government gets to use the cash out of our 401k's to pay their debt and then when we die, they basically get the rest. I just want to have the chance to use what's mine for my own good before it all gets taken away.

my take is this is Conspiracy Theory. it is unlikely this would ever pass the Supreme Court since assets in a 401k do not belong to the govt they cannot force you to invest in them. There is clearly a violation of rights here to contest. i think it easier for the govt to come up with a way to tax your Roth.

My reasoning was that today's tax rate +the 10% penalty will still net me 49.6% of my total, and that's about exactly how much of my $600k I have actually put in. So net no loss.

And you will have squandered the 100% net gain you have accumulated over the last 11 years whereas your mortgage sits at a paltry 5% (and possibly less if you refinance). in the long run you will most likely have a net loss on this transaction and also have the stress of rebuidling your retirement and losing out on the extraordinary power of compounding interest/gains that could occur with your current sizeable 401k balance.

my advice:
1) do NOT cash out 401k (leave as is)
2) stop investing NEW money into your 401k and use that money to pay down $80k CC/unsecured debt
3) if you can afford to contribute to 401k and an IRA, consider contributing to a nondeductible IRA and converting it to a Roth IRA since the income restrictions for conversions has been lifted in 2010. (if you have existing pre-tax IRA money from a rollover or SEP-IRA then consult your accountant since you will have to pay taxes on the conversion).
4) once #2 is complete, CONSIDER paying off your mortgage as fast as possible (but i still don't think it's a given to do that)

[DrK1992]

Thanks you all for your well thought out answers. After considering all of them, and scheduling an appt with a fee only financial advisor, I am going to hold off on my crazy idea for now. I feel less of a sense of urgency and not so panicked now after reading your educated comments! I will sleep better! God Bless! BTW, I also found a Dave Ramsey course at a local church that begins in August and I enrolled.

[clydewolf]

, and scheduling an appt with a fee only financial advisor,

GOOD MOVE #1!

I am going to hold off on my crazy idea for now.

The only way to get cash out of a 401k is to separate from your employer, or on a loan. Not all 401k plans have a loan feature.

I also found a Dave Ramsey course at a local church that begins in August and I enrolled.

GOOD MVOE #2!

I don't know what investment options you have in your 401k plan, but after the Dave Ramsey Course you may want to read Austin Pryor's book, Sound Mind Investing. Austin publishes a monthly financial newsletter too, Sound Mind Investing. You can learn more here: www.soundmindinvesting.com

[pochax]

When going to Dave Ramsey's course, concentrate on the tools to decrease your debt. Pay little attention to his investment advice (it is not solid).

[TimFrat]

I agree with pochax. Dave Ramsey is an excellent motivator and helps motivate you to get out of debt - but his investing advice and outdated market return projections are misleading.

[4jacks]

I vote no. Taking it out of the 401k is like borrowing it at 45% interest rate.

keep us updated

[An72]

If you want to cash it out then go for it. Just talk first to the human resources department at the company with which was you had or have the 401k. Decide the percentage of 401k funds that you want cash out. It's an option to cash out only part of the 401k and then rollover the rest into another fund. Calculate the cost of the cash out. Not only is there a 10 percent penalty for cashing out a 401k before you are fifty-nine and a half, it's also subject to state and federal income taxes. Submit the cash out paperwork to the 401k administrator. The 401k administrator usually subtracts out the ten percent withdrawal penalty prior to payment, while the federal and state taxes are your responsibility. Verify that the amount of the 401k cash out is correct when you receive the check or electronic transfer. If it is not correct, ask the 401k administrator for explanation of the discrepancy.

[Axel]

11 years is really a long time . . . !!!
that is why i prefer trading instead of investing , trading gives you profits in a short period of time .

[jabberjaw45]

DrK1992,

I say YES to cashing out. I’m probably the only one here that cashed out part of my IRA this year. The traditional IRA I have is a combination of two old company 401k rollovers. So there is no longer any employer matching contributions. Bush tax cuts were extended for 2011 so you can do it this year. Have you ever looked at the federal tax brackets from 1986 and earlier? See link below. Highest tax bracket over the years is 94%! Currently we have some of the lowest taxes in the history of our country. In 20 years when I’m 65, who knows….there is good chance is could go back to pre 1986. Also, the current financial crises and debt is only going to be cured by raising taxes. Just look at the history. Not to mention, you could lose over 10% if have all your money in mutual funds…be ready for another crash. 10% penalty may look like peanuts after the next one. Right now worse case is 35%+ penalty if you make over $379,150. No financial planner will tell you to cash out of a 401k..that is how they make their money. I just base it on common sense. I paid off my mortgage (5% rate) and the rest is in AMEX bank, Ally Bank, etc earning around 1.30% now. After the stock run up recently I got out. I’m just waiting for CD to get back to 3-5% and then lock in long term. Stocks are just too risky these days. It just feels like Las Vegas to me…This way I can sleep at night knowing I’m not losing money because the middle east is terrorizing us. I’m close to being financially independent…. I plan to quit my current job and work (volunteer) fulltime in charitable organizations and people in need. Grabbing the IRA $$ just seemed like a safe bet to me. Remember you don’t have to take all of it either. Also, you have your itemized deductions, etc to take into account before applying chart below..I paid 38% (28% + 10% penalty) on IRA withdrawl last year (that includes 10% penalty). The lowest bracket could be 28% in 10 years!
See> Look at the Reagan years!
http://www.taxfoundation.org/files/f...y-20080107.pdf

http://www.ntu.org/tax-basics/histor...ividual-1.html
With the extension of the Bush-era tax cuts, this is how the 2011 Federal Income Tax Brackets will look:
Tax Bracket Married Filing Jointly Single
10% Bracket $0 – $17,000 $0 – $8,500
15% Bracket $17,001 – $69,000 $8,501 – $34,500
25% Bracket $69,001 – $139,350 $34,501 – $83,600
28% Bracket $139,351 – $212,300 $83,601 – $174,400
33% Bracket $212,301 – $379,150 $174,401 – $379,150
35% Bracket Over $379,150 Over $379,150

•1917: War Revenue Act of 1917 increases rates. Tax brackets range from 2 percent on income of $0-$2,000 to 67percent on income of $2 million and higher.
•1920s: Tax rates are cut because the economy is doing well. The highest marginal rate decreases to 25 percent.
•1930s: Big increases because of the Great Depression. Lowest rate is 4 percent. Highest rate is 79 percent. Income of $90,000-$100,000 is taxed at 59 percent. In 1933, there are 55 tax brackets, mostly in 1 percent increments.
•World War II: Great tax increases to fund the war. The lowest rate in 1944 is 23 percent, for income of $2,000 or less. The highest rate is 94 percent for income of $200,000 or more.
•1981: Economic Recovery Tax Cut of 1981 lowers tax rates. Highest tax rate drops from 70 percent to 50 percent.
•1986: Tax Reform Act of 1986 reduces rates further and cuts the number of brackets. For the 1986 tax year there are 15 tax brackets. For 1987, there are five. [source: The Tax Foundation]

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[4jacks]

Jabber, while I can't agree with you 100% you've certainly done your homework. You've still made a gamble that 38% now will be better than what ever tax rate there is in the future. While no one knows the future, you DO know what you paid now, and you're okay with that, so who's to say it was a bad decision.

I would like to point out that raising taxes is most certainly not the only way our country could get out of debt. While it is a very viable option, there are a million other scenerios that could happen. Watching the situations in Europe will certainly give us more insight. Of course we could always print our way out of debt. That has been done before. Another option, and the option that I would pick as most likely to happen, is that we will just continue on this debt cycle for our lifetimes. The debt ceiling will continue to rise, congress will continue to spend more than we produce, and 50 years from now people will still be having the same conversation, except with extra zeros at the ends of the numbers.