Took Lump Sum Pension-Paid Off Mortgage

[zeros]

Had a client who elected the option of taking a lump sum payout of $200K and subsequently no monthly pension (forever). He paid off his $200K mortgage so now has no interest deduction. I believe his tax liability would be $65K from taking this distribution. He wants to take additional money from his 401K to pay the taxes. This would create an even larger tax liability. I was thinking about having him take a short-term loan of some kind and pay sufficient estimates so he won't get a penalty. Then take the 401K distribution in 2012 and pay off loan. Any payment to the state would be a deductible item for 2011.

Any good ideas out there?

[JohnH]

I'd run the numbers very carefully. Depending upon when he got the lump sum the net cost of the penalty may be about the same as the interest on the loan, especially after transaction costs.

Have you calculated his "safe harbor" estimated tax payment? If he only needed $5k of additional withholding based on 2010 tax liability, for example, then he could take $6k from the 401k in 2011 and direct the trustee to withhold $5k in taxes. All withholding is treated as though it was paid in equally throughout the year. Even though the marginal tax rate would be higher on the relatively small 2011 withdrawal, it might be less hassle provided the amount needed isn't too great. Then he could still take the 2012 withdrawal to pay off the balance in April.

Is he subject to AMT in 2011? That will determine when he gets the most bang for the buck in paying the state estimates. Sure would be embarrassing to tell him to pay the state income tax in the high income year thinking he's going to get the benefit of the deduction at the higher Fed rate and then watch it disappear on the 6251.

Sounds like an interesting analysis, and worth a few hundred dollars in billable time.

[oceanlovin'ea]

age

How old is this person?

Years ago I had a truck driver retire and do the same thing. He was in his 50's. They had to take money out every year to pay their taxes on the previous years withdrawal. She could have killed him.

Linda, EA

[zeros]

60 Years Old

He is 60 years old and his wife is still employed.

How old is this person?

Years ago I had a truck driver retire and do the same thing. He was in his 50's. They had to take money out every year to pay their taxes on the previous years withdrawal. She could have killed him.

Linda, EA

[JohnH]

Just out of curiosity, do you know what the rate was on his $200k mortgage? And does he have lots of other itemized deductions? He is right on the edge of a situation where this might actually be a good strategy under certain circumstances. (not great, but not really stupid either)

I say that partially because the home mortgage deduction is often way overrated. It's nice as a threshhold deduction to open up the deductibility of prop taxes, state income tax, and contributions, but as a stand alone deduction its only value is to mitigate the real cost of borrowing money - not really a good reason if there are options to pay it off. And its only real value is the total excess of itemized deductions over the standard deduction, times the marginal tax rate.

[zeros]

Mortgage Rate

I am not aware of what the rate was before he paid it off.
.

Just out of curiosity, do you know what the rate was on his $200k mortgage? And does he have lots of other itemized deductions? He is right on the edge of a situation where this might actually be a good strategy under certain circumstances. (not great, but not really stupid either)

I say that partially because the home mortgage deduction is often way overrated. It's nice as a threshhold deduction to open up the deductibility of prop taxes, state income tax, and contributions, but as a stand alone deduction its only value is to mitigate the real cost of borrowing money - not really a good reason if there are options to pay it off. And its only real value is the total excess of itemized deductions over the standard deduction, times the marginal tax rate.

[Golden Rocket]

Seasonalize 2210 Penalty

Don't forget - if he ends up with an estimated tax penalty, and this ginormous distribution was taken late in the year, he may save money by taking the seasonal exception on the 2210 calculation. Lots of work by dividing income and expenses by time periods, but often saves money for the client.