I was downsized from my job 9 months ago and continue to be unable to find employment. Cash is just about gone, so the time has come to make a financial move to avoid mortgage delinquency and maintain COBRA health care payments. I am younger than 59.
Retirement funds currently reside in the 401K my employer used to sponsor. If I understand the law and my options correctly, if I roll the entire 401K balance into an IRA I can:
Take an "unlimited" periodic withdrawal from the IRA, say monthly, to cover mortgage and COBRA
The funds used for COBRA payment are exempt from 10% penalty
An amount of funds, equal to the amount of funds used to pay college tuition in January 2008, is exempt from 10% penalty.
These "penalty-free" amounts are not available were I to take the withdrawals from the 401K.
If this is a generic question, regarding the early withdrawal and penalty differences between 401K and IRA, do I have an accurate understanding?
You are using two terms here: Periodic withdrawal, and COBRA. COBRA as part of medical insurance will be discussed below.
The rule applying to periodic distributions are not unlimited distributions.
You have to use an actuarial formula to calculate the amount of your annual periodic distributions, which will constitute a Series of Equal Periodic Payments, that is designed to draw out your IRA by the end of your statistical life span.
The IRS provides a Table in IRS Pub 590 that you can use, or you might consider obtaining a professional opinion from a tax professional specializing in this area. Many, not all, IRA custodians will even use the IRS method and do the math for you.
The amount of the annual SEPP must be distributed for at least five years and must continue until you have reached age 59 1/2.
So it is not an arbitrary or unlimited amount, and this particular exclusion from early distribution tax is also available for
401k plans.
Yes, generally. Here is what Pub 590 says:
BEGIN QUOTE Medical insurance. Even if you are under age 59 1/2 you may not have to pay the 10% additional tax on distributions during the year that are not more than the amount you paid during the year for medical insurance for yourself, your spouse, and your dependents. You will not have to pay the tax on these amounts if all of the following conditions apply.
You lost your job.
You received unemployment compensation paid under any federal or state law for 12 consecutive weeks because you lost your job.
You receive the distributions during either the year you received the unemployment compensation or the following year.
You receive the distributions no later than 60 days after you have been reemployed. END QUOTE
Also if you have allowable medical expenses in excess of 7.5% of adjusted gross income, you can exclude the amount in excess of
7.5% of AGI from the 10% early distribution tax. Do not count the COBRA payments for two different exclusions; just count COBRA payments once.
Yes. Further, you may still use those same tuition funds to calculate an education tax credit.
Thank you, Mr. Kamlet, for your quick reply. One clarification requested:
I suspect I may not have been clear - pardon any misuse of the language. It is not my intent to draw out distributions from my IRA starting now until the end of my life span. My intent is to use funds, drawn out monthly, to cover mortgage and health insurance until I am able to find work. Two months, six months, twelve months... until I find work or, worst of all cases, the IRA is depleted. So, I am not planning on initiating a SEPP, if that is a retirement plan, at this time - just trying to get some cash out to keep my home and cover COBRA for "a period of time".
OK. Then ignore the SEPP discussion. I included it since many people are aware there is an exclusion available for a plan to take Substantially Equaly Periodic Payments and the word Periodic was used here. Just ignore that discussion.
I would only add that a distribution from the IRA in 2009 could be exempt from the 10% penalty if used to pay qualified higher ed. expenses incurred in 2009. The OP asked about January "2008" tuition, not January 2009 tuition. Assuming it was a typo, there is no issue. If not a typo, then there would be no exemption from the 10% penalty for tuition paid in 2008.
Please do NOT consider this as a personal assault, but I find it most annoying whenever someone posts something like "I am younger than 59." If you'd simply tell us your actual age, it would be more beneficial. You've gotten some good answers to your post, but I did not see this mentioned -
The premature distribution penalty also does NOT apply if you are a participant in a 401(k) plan and take distributions when A) you are separated from service (no longer employed) AND B) at least age 55.
So had you told us you were 54 we could have given you several exceptions to the penalty for you to explore.
Had you told us you were 58, we could have simply told you that the premature distribution penalty should not apply to you.
But since you told us neither, we have to guess and post considerably more information than would normally be necessary.
I agree with you wholeheartedly. If he does meet the age 55 rule (50 for a qualified public safety official), the only options probably available are a complete rollover or a full distribution and a partial rollover within the 60 day period. Any part not rolled over would only be subject to tax (no penalty).
I've never seen a plan that allowed a separated employee to take a partial distribution or do a partial plan to plan rollover. That's not to say that one doesn't exist.
I did not realize that there were age-specific consideration other than 59, my apologies. I sincerely appreciate the help provided on this forum. I am 51.
My largest monthly expenses are my mortgage and health care premium for my family. With cash depleted, and UI as my only income, my options are to stop making payments on both or begin withdrawing monthly from retirement funds until the job market improves. (Note: I am very active in job search and skill development).
It has been made clear that specifics help, so:
I have been paying COBRA for 9 months in 2009, at the ARRA subsidized rate of $500/month. My undestanding is that an IRA withdrawal of $4500 in 2009 would be taxable, but penalty-free as a result. Is that correct?
In January, I paid $5000 towards college tuition for a dependant. My understanding is that another withdrawal of $5000 in 2009 would be taxable, but penalty-free. Is that correct?
Since January I have made payments on a PLUS loan (alternative loan for parents of college students, applicable toward higher ed expenses) at $100/month. Total, so far, is $900 in 2009. Is it also true that an IRA distribution of another $900 in 2009 would be penalty-free?
Thanks to all who have contributed toward my understanding.
No problem, I wasn't trying to beat you up (sorry).
Maybe - there is an exception to the penalty under IRC 72t BUT this exception ONLY applies to withdrawals from an IRA NOT a company sponsored
401k Plan.
Again - no penalty but ONLY for IRA monies, not 401ks.
Never heard of this - payments on a loan are NOT the same as payments for tuition. You got the tuition deduction or credit when the tuition was PAID, even if you paid it with loan proceeds. Paying off the loan won't get you any consideration that I'm aware of.
The trick for you is going to be coordinating your withdrawals. Some 401ks will allow you take partial withdrawals AFTER leaving service while some will let you keep your money there but force you take it all if you try to take any. This is where the balancing act is going to come into play.
You need to get info from your old firm about what your withdrawal options are. Can you take a partial withdrawal or must you take all of it.
Then you have to weigh rolling all of it to an IRA so you can take some out without a penalty to pay for allowable expenses against leaving it there.
At 51 its a tough call to make and I can't help you much without getting a lot of info from you, WAY more than I'd feel comfortable having you post here. And, quite frankly, this is a bit more work than I'd do for free. Though I would think it wouldn't cost you more than a $100 or $200 to get a professional to assess your situation and give you some guidance.
The up side to leaving it where it is means that once you hit 55 you can access it penalty free for any purpose. But you'd have to wait about 4 years for that to happen.
The down side is that you'd pay a penalty if you take it from a 401k to pay tuition and insurance.
The best option might be to move enough to cover the insurance, tuition and taxes to a personal IRA, then take the money from the IRA. But again, you need to know if a partial rollover is allowed by your plan.
You also have to keep in mind that the law only allows for ONE rollover a year. So if you roll $20K now you'd have to wait a full year to do it again. You can get around this by doing a direct trustee to trustee transfer.
The age 55 does not work the way you describe. If you are not yet age 55 in the calendar year when you terminate your employment, you have to wait until age 59 1/2 or meet one of the other exceptions.
I will double check my understanding - I did think I was wrong once before but it turned out I was mistaken about that. I can't be right all the time (for free!) .
OK, perhaps I have temporarily lost my mind - this is two posts that I had that have been corrected. I'm starting to get a complex. I'll double check on this as well.
Thanks for setting me straight, Gene E. Utterback, EA, RFC, ABA
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