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Retirement Funds

I am changing jobs for health reasons and going to a lower stress (and pay) job. My new job will not have a 401k plan. I just over $22k in my 401k account. If I take the 401K money and use it to pay down debt can you tell me how much of the 401k I will keep and how much I will lose in tax and penalties? Thank you. Steve

Dear Steve:

If at all possible, please try not to cash in your 401(k) retirement plan to pay down your debt. Not only are the tax consequences too steep but this is your future financial security you will be eliminating that you will not be able to recoup.

If you cash in your 401(k), the minimum tax liability you will have is 15% plus a 10% penalty for a total of 25%. From your 22K, after you pay your tax liability, you will net a maximum of $16,500.

Dear Susan & Co.,

I have a couple of questions that I hope you can help me with...

1. My wife and I have around $8,000 we would like to invest at this time. Can you advise me on where to invest it??? The stock market for the past year has really been a wild ride and we are not too sure if we should invest in stocks at this time...What do you recommend???

2. I currently have a $200 U.S. Gov. savings bond (EE) deducted from my paycheck each month...I recently found out that it is taking anywhere from 10-15 years for them to reach maturity...Should I cancel these bonds and invest in something else???

3. We have a $5000 bond (EE) bought in 1997 which is currently worth $2,678 and several $1000 bonds (EE) purchased after 1989 which have not matured. We are having a hard time finding out the interest they are drawing. Can you tell us how to find out the interest rates for these bonds. Should we hang on to these bonds or convert them to something else???

Thank you for your help...looking forward to your response. Dennis & Jo

Dear Dennis & Jo:

You are asking for investment advice and since I am not a Registered Investment Advisor, I cannot tell you what you should or shouldn't do with your money. I would be in violation of Securities and Exchange Commission (SEC) rules and regulations. Sorry. You will need to seek the services of a properly licensed and registered financial planner. Preferably seek the services of a Certified Financial Planner (CFP).

What I can do is give you my opinion on a few comments you have made. Yes, the stock market has shown a lot of volatility recently but this is to be expected. Statistically, over an extended period of time, the stock market has show a far superior return than any other investment. In my opinion, if a person is a long term investor, the stock market is the place to be. Now where specifically in the market you should be is up to an investment advisor to suggest.

To find the current interest rate on various government issued bonds call: 1-800-US-BONDS (1-800-872-6637).

You might want to subscribe to a publication like "Money" magazine for investment advice. Good luck on your ultimate investment decision. It's refreshing to hear from people like you two who are concerned about where to invest their money and not how to get out of debt.

Dear Susan & Co.,

I have about $4000 in my 401(k) plan, and I have about $3000 in credit card debt. I am leaving my job to start with another company and I am faced with the choice of rolling my 401(k) over into my new company's plan or taking the penalty and closing it out to pay off my credit cards, then starting over with my new employer's plan.

I am 28 and single. I know that the advice is to first get out of debt, then build up an accessible savings of two months' living expenses or so, then start saving for retirement. Would it be in my best interests to close out the 401(k) to pay off my debt, build up a safety net in savings, and then start contributing to the new 401(k)? Or would I lose too much by starting two years later? Thanks, April

Dear April:

You definitely will lose too much by starting two years later. If a person asked me when they should start saving for their retirement, I would say do not wait. They should start as soon as they received their first paycheck. So my suggestion is to not cash in your 401(k) plan. There are far too many negatives and not enough positives in cashing your 401(k). The first negative is you will have to pay income tax plus a 10% penalty, or a minimum of at least 25% in Federal income tax on any early withdrawal. Hopefully none of your credit card debt has an interest rate that high. The second negative is the chances are overwhelming you will not replace the $4000 that you with draw. The third negative is you would be starting later than you should in funding your retirement account.

Instead of having to refund your 401(k) plan, concentrate on paying off your credit card debt. If the interest rate on your credit cards is around 18%, by paying $110 per month, you can be out of debt in about 3 years or $90 per month will get you out of debt in about 4 years. This is what I would do if I was in your situation.

Dear Susan & Co.,

I will try to be as brief as I can without leaving out critical information. Here are the facts:

• I am in $25,000 of debt at the moment. I have gone through stress, anxiety attacks and depression, relating to this.
• I have been working on paying down the debt and I am slowly accomplishing this.
• I am looking into buying a small townhouse. (FHA Loan of approximately $100,000 at 7%) In order to do so, I need to reduce my debt.
• I have a stock purchase/401K plan with my company. I contribute 6% and they match with 6%.
• I have approximately $41,000 in this account.
• If I were to take money out, I was told that I could have the employer match of approximately $17,000.
• My father has offered a gift of $6000 as a down payment on a house.
• If I take the $17,000 out of the 401K, it should amount to approximately $14,000 after taxes and the 10% penalty on the amount over $10,000.
• This will leave me with my car payment of $366/month that will be paid off in May of 1999 and a personal loan of $150/month that will be paid off in 3 years (or less once I can increase the amount that I pay).
• At the moment, the $17,000 goes with the flow of the stock value. I am paying interest on my credit card debt ranging from 5.9% (introductory rate) up to 16.5%.
• If I take this money out to pay 56% of my debt, once I buy the house I will actually be reducing the amount of money that I pay out, by at least $200-$300. This will decrease even more once my car is paid off.
• The January following the car payoff, I can increase my 401K withdrawal to 15%. This should help somewhat to offset the amount taken from the account.
• I am 33 years old, so I have about 30 more years to participate in a retirement plan.

Dear Bonni:

You're asking some tough questions and I'm going to give you some tough answers. I do not recommend you withdraw the money from your 401(k) plan. The tax penalty is too severe and the odds are you will most likely never make up this difference, even though you say you will increase your contribution from 6% to 15%.

Look at the numbers. In 30 years, your $41,000 can grow to over $800,00 without you contributing another cent to the plan. In order to get the same results by starting from scratch, which you would be doing, you would have to contribute $360 every month for the next 360 months (30 years). That is just to equal where you are now. It's not worth it to risk what you have worked hard to accomplish with your 401(k) plan. You would be better off terminating your monthly contribution to your 401(k) and putting this 401(k) money into a savings for your down payment. But then you would lose your employers 6% matching contribution, which is not a good idea.

I know you really want to become a homeowner. This is the dream of most people and I applaud you for your desire. Now is not the proper time because your finances are not properly in place. Strive to get out of debt first. Get your car paid off then put what you were paying in car payments into a savings account to accumulate your down payment money. You're 33 years old. I was 35 years old before I bought my first house. You have time. Don't rush into something you will regret later on. Good luck.

Dear Susan & Co.,

My wife and I have just under $30,000 of unplanned debt on 4 credit cards. We have no other debts, and our combined gross income is about $80,000. I can take a loan from my retirement plan at work in which I have over $100,000 invested. A loan of about $30,000 is to be repaid to myself, pre-tax, and the interest also goes back into my own account. What are the bad points to this plan? If my employment with the company terminates, will I need to pay back the loan all at once? Thanks! Doug

Dear Doug:

Interestingly enough, a recent newsletter from New England Funds features an article entitled "Borrowing From Your 401(k) Plan? It’s More Costly Than You Think." Several downside points are listed.

• Loans take money out of the investment stream for a time period and reduce the benefits of tax-deferred compounding.
• Since gains in the market cannot be timed, you may lose some important investing opportunities and jeopardize your retirement security.
• You must repay the loan with after-tax dollars and the interest is not tax-deductible.

Obviously, the anonymous author advises strongly against 401(k) loans.

Generally, if you leave a company before the loan is repaid, the remaining monies in the retirement funds are used to cover the balance of the loan. If the unpaid balance is considered an early withdrawal from the plan, you could be subject to hefty penalties and taxes. Talk to your human resource director to get the specifics of your company’s plan.

An option is to restrict your living expenses for the next 6 months, applying freed-up dollars to debt payments. You’ll benefit from the financial discipline, pay the debt down and make a smaller dent in your retirement should you then choose to borrow. Good luck.

Dear Susan & Co.,

I have a credit card balance too large to mention. I have a 401K and am considering taking out money to pay these debts. Do you think this is wise? Or should I try real hard to keep on paying these cards with whatever money I have? I'm very desperate and stressed out! I can't think of any other alternative than bankruptcy, but I do not want to do that if at all possible. Nancy

Dear Nancy:

My apologies. I misplaced your letter or I certainly would have answered more quickly.

If you are nearing retirement, you have limited time to replace retirement funds borrowed from a 401K. If you have many work years left, then research the terms of a 401K loan: amount available, interest rate, length of loan, any penalties, and the monthly payment.

If the facts point toward an affordable loan, the 401K might be your best bet. With your stress reduced, you could take a part-time job to build a savings account to replace the credit cards you've been leaning on.

Because if you get the loan, you're going to close all the accounts and send the cards back. If you think you're in pain now, imagine having a 401K loan deduction AND your credit card payments. Counselors see it way too often.

Next, be honest about what got you in this mess to start with. Are you a compulsive spender? What's going on? Figure it out and then quit doing it.

Your debt may be too large to mention, but if the 401K approach doesn't work, don't let embarrassment keep you trapped in the cycle. CCCS counselors are pretty hard to shock. If you need more information, please write back.