Cashing out IRA for debt payment

[betseyjane]

My husband and I have some major (to us at least - $22,000) credit card debt and are looking into cashing out his IRA. It was a 401k a few years ago, that we rolled into an IRA when he transferred jobs. It has about $20,000 in it. We're just in a very bad spot right now, and have no other ideas on how we can get out of this. We've had a number of things happen over the last 2 years to contribute to this debt.

Could anyone tell me any info about the questions we have?

1 - We know we'll pay the 10% early withdrawal (we're 31 years old)

2 - Will we pay the federal taxes right away? (Will they take them before distributing the check to us?)

3 - Will we end up paying MORE in taxes when we file our 2008 returns?

4 - Combined, we make about $85k/year

Thanks in advance, if anyone can help...

[mblatour]

here's my two cents...

1. Yes you'd pay the 10% early withdrawal penalty.

2. Federal & State taxes should be withheld right away. I'd be sure of it if I were you.

3. You may end up paying more when you file your '08 taxes and here's why. You say you make $85,000 a year. But due to the $20,000 withdrawal, you'd actually make $105,000 for the year. That may/may not put you into a higher tax bracket. You may lose certain credits you were previously eligible for as well. Depending on what your deductions are and where your federal taxable income ends up, you may owe additional federal & state tax. In my opinion, pay the taxes up front, or you'll just end up paying them next spring.

[outwest]

Rule of thumb..

you'll pay 45% of the withdrawal in taxes (Federal, State and penalty).

Not knowing which state you are, but at your income level, I think this will be pretty close.

And, as the old oil change commercial said, "Pay me now or pay me later"

[ChEAr$]

Total taxes

you'll pay 45% of the withdrawal in taxes (Federal, State and penalty).

Not knowing which state you are, but at your income level, I think this will be pretty close.

And, as the old oil change commercial said, "Pay me now or pay me later"

How do you get 45%? Looks to me they're in the 15% federal bracket, plus of course the
10% makes it 25%. Plus state rate.

[betseyjane]

I'm in Wisconsin

[outwest]

How do you get 45%? Looks to me they're in the 15% federal bracket, plus of course the
10% makes it 25%. Plus state rate.

$85K less standard deduction and 2 exemptions = $67.5 That's the 25% marginal bracket on TTB. plus the 10% plus 7% WI state. = 42%

With no more information, 45% is a nice rule of thumb.

[Bonnie]

[ Looks to me they're in the 15% federal bracket, plus of course the
10% makes it 25%. Plus state rate.

Problem is adding other income puts taxpayer in the 25% bracket so minimun of 35% will go to taxes--25% federal and then another 10% penalty, plus possible state tax as well. I saw this happen a few years ago, lady took $60,000 from 401-K knowing she owed tax an penalty but did not count on the 25% bracket. After they had already withheld 20% when she withdrew the money she still owed another $11,000 when she filed. She ended up doing a home equity loan just to pay her taxes that year.

Betsyjane, I sent you a private message as well. Please check it.

Bonnie

[taxmandan]

Did your debt counselor suggest you do this?

If so, you need a better counselor. You're going to pay half the money out in taxes as stated earlier and then will have nothing for the future (no IRA). Better to get a night job and pay those bills by laboring harder and spending less. You are selling your future to pay for the past, bad idea. Better to bite the bullet and pay off the debt by working it off.

[veritas]

Have you considered

getting a second job?

I am in total agreement with Taxmandan.

Taking money out if a retirement account is just so wrong on every level. Not only are you going to give up a large percentage to tax and penalties, most likely that money will never make it back into your retirement savings. If I had invested $22,000 30 years ago in a good balanced fund the present value would be worth $588,000 today.

[S T]

I have had many

I concur with all of the prior posts.

You will lose approx 30 - 50% of gross distribution to Federal and State Income tax, plus penalties. So $20,000 is going to cost you in tax dollars approximately $6,000 to $10,000, that just doesn't make any sense. what you will net is only approximately $10,000 to $14,000 which will not pay your debt off!

Consider paying an extra amount to the debt. If you make only the minimum payment on the credit card statement you will never get ahead. You need to make the interest posted at the month end statement plus an additional amount so it goes to paying off the balance.

In the meantime, make up a budget and do not use your credit cards. If you can't pay cash, don't buy it!

Sandy

[ED SMITH]

This is not as simple as everyone is suggesting. When credit card balances go over 75% of the limit, the interest rate usually goes up to nearly 30%. If they keep on paying the credit cards it will cost them over $6000 a year and the balance is unlikely to diminish much. It might be better to cash out the 401k and pay down the cards below the 75% and be returned to a lower rate so that the same payments they are making now would have more going to the principle.

There are credit card debt reduction companie that can consolidate the payments and negotiate lower interest rates, although I would be very careful in selecting one. Another thing to consider is that the 401k might decrease in value in the next year or so with the sluggish economy.

All options have to be looked at carefully.

[veritas]

I think it's pretty simple

Don't spend money you don't have. Get another job and take care of business.