Eschewing Insurance and Cashing out the 401(k), Part 2
Every Monday is Intents and Purchases day at Living Behind the Curve.
When last we left our tale of financial intrigue, I had given up on the medical insurance game and was seeking a $10,000 self-insurance starter kit, in the form of my 401(k). Rather than bet my health and wealth on a blind roll of the dice, I decided to poke at the glorious interweb and see what I could find.
Before I get started, a few happy little disclaimers: I’m not a professional, I have no idea what the hell I’m doing, and I don’t recommend this to anyone. Got it? Good. I’m also not quite 30, and I probably wouldn’t even have considered this if I were a few years older.
If you want to cash out your 401(k), it’s going to be painful right off the bat. Here are my (at this point, completely hypothetical) numbers:
401(k) amount: $10,000
-20% tax: ($2,000)
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Cash out amount: $8,000
-10% penalty: ($800)
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End up with: $7,200
It’s not quite as simple as an $1,800 hit, though. That 20% tax withholding is actually an income tax, and depending on your income and tax structure, it washes out quite nicely:
If I quit my job for good on August 15 of this year and didn’t make another red cent, my income and taxes would look something like this:
Total income: $30,000
Taxes paid: $5,800
Taxes due: $3,306
The big difference there is caused by a shift in tax bracket (link to the calculator I used at the end of the post). Of course, I’m not quite lucky enough to be able to quit my job and eat bon bons, so let’s add in $5700 income from a part-time job from August 16 through the end of the year.
Total income: $30,000+$5,700=$35,700
Taxes paid: $5,800+$570 (because the PT salary falls into the 10% bracket)=$6,370
Taxes due: $4161
So, I’m still ahead of the game. Now let’s see what happens when I add in that 401(k) distribution:
Total income: $35,700+$10,000=$45,700
Taxes paid: $6,370+$2,000 tax paid at time of withdrawal=$8,370
Taxes due: $6,511
That leaves me with a $1,859 refund, which almost entirely replaces the $2,000 tax I paid at withdrawal, washing out to a 401(k) cash-out cost of $941 ($2,000 tax paid-$1,859 refund+$800 penalty).
Now, I know damn well that taxes are never this simple. I also know that I’m flying by the seat of my pants here — the only info I could find after 2 hours on the IRS site was about sponsoring 401(k) plans and how the IRS employee plan works.
There is, of course, more. My original reasoning for cashing out my 401(k) was to fund a self-insurance plan, right? Right. So, stick that $9,059 in a high-yield savings account, add $89.11/month (what I would have spent on health insurance), and sit back and do nothing.
So what now?
Now that I have a full-time-with-bennies job lined up, the numbers are quite different. If I don’t mess with my retirement money, I’ll come out about $700 ahead on my taxes. If I do cash it out, I’ll still be ahead on my theoretical taxes, but only by about $200, which brings the cash-in-hand value of my 401(k) down to about $7,400. This sounds like a lot, but it’s really not that bad, considering if that $10,000 would have been added to my income, I would have lost almost as much to income tax. And, yanno, half of that $10,00 is free money (I was lucky enough to be fully vested from day 1 in a 1:1 match plan), so it’s really not that bad.
Why on earth would I want to mess with retirement now, though? Well, I’m certainly not giving up on retirement. I’m a lazy SOB, and I look forward to those damn bon-bons someday. What we are considering now is taking that money and investing it in real estate.
Real estate investment (not the crazy “Flip This House shit) is something Mer and I have always planned to do someday. When I made the decision to leave my job, however, an income cut meant that our investment plans would be pushed back quite a bit. The 401(k) money may give us the opportunity we need, with a strict schedule for replacing that retirement money within a set period of time.
Next week, Mer and I will dish about our dreams of being robot overlords…I mean…landlords. By then I will be at the new job, so I will probably have been forced into a 401(k) decision. Stay tuned.
The rambliness of this post is brought to you by my Spanish midterm, irregular preterites be damned.
Sources: 401(k) penalty information Calculator
