Advice for cashing out an IRA
December 18, 2014 10:29 AM   Subscribe

I have about $3,000 dollars in an IRA from before I went back to school and was working full time. Half of that is money I had contributed, and half is from my former employer. Due to a teaching assistantship falling through this semester I could use a little bit more cash to feel financially secure. I'm considering cashing out the IRA, but would appreciate advice.

I checked out this question, which was very helpful, but I'm still curious about a few aspects given my particulars.

You aren't my financial adviser, but here are more relevant details,

The account will reach maturity in October of the coming year, which is later than I'd like to wait. However, according to the BoA rep I just talked to, the penalty from the bank for early withdrawal is relatively low (like 5 dollars, or something).

The interest on the money is incredibly low. I would rather be financially secure now than be earning a microscopic amount of interest.

I'm in Maryland. The BoA rep said that in addition to the federal penalty, there would also likely be a penalty from the state.

Specifically I'm wondering:
>I'm unsure of whether this would bump me into the next tax bracket. Given last year's TurboTax file, is there an easy way I could figure this out?

> What should I keep in mind for tax season if I do this? Are the penalties assessed at withdrawal, or would they show up in my tax bill for the coming season?

> I've heard that taxes can be reduced if this is being used for education. I would be using it for housing while I'm in school and travel to conferences. How hard is this to document if I do my taxes myself and don't have an accountant?

> Speaking of accountants, how much would consultation on this cost if I wanted to get help deferring the penalty. 10% of 3,000 is 300... would I be paying more than that in billing an accountant to get a more optimal distribution?

> I'm thinking that this is basically a savings account that my former employer doubled the value of. Therefore if the penalties are far enough below 50% of the total then it makes sense to withdrawal it, rather than letting BoA sit on my money in return for a pittance in interest. What would the total amount in penalties be once everything was said and done?
posted by codacorolla to Work & Money (8 answers total) 2 users marked this as a favorite
1) Bumping you into the next tax bracket doesn't matter. If you are $1000 into the next tax bracket, only that $1000 gets taxed at the higher rate.

2) You don't have to keep much in mind. When you fill out a distribution form it will allow you to withhold money for taxes if you want. In either case, you'll get a 1099 from the company telling how much you took out and how much they withheld (sent to the IRS) for you. If you don't want to pony up the whole tax bill on April 15, asking them to withhold is the way to go.

3) The fact that it has a maturity date suggests it's a CD or something? What does that mean?

4) You are going to be penalized out the wazoo. When I'm doing back-of-the-envelope calculations, I assume I am going to get just over 50% of the total (between taxes and penalties). In reality, you'll get slightly more than that, depending on your tax bracket. The rest of it goes to Uncle Sam.

I'm not saying don't do it, but I'm saying that you'll be giving up $3000 in order to get $1500 or a little more. It's a hell of a bite. As far as I know, the penalties show up at tax time but that might depend on BofA. See if you can find one of their IRA Distribution Forms. It will tell you most of what you need to know as you go through the various check boxes, etc.

5) Your options are not limited to withdrawing everything or letting BofA give you a pittance in interest. You can move your IRA to anywhere and do actual investing with it, in the actual market.

6) When you say "get help deferring the penalty" what does that mean?
posted by small_ruminant at 10:39 AM on December 18, 2014

Okay, I just thought of how bumping you into the next tax bracket might matter. It's not about the tax brackets, per se, but about phasing out of different credits. For instance, look up the Earned Income Tax Credit to see if you would otherwise be eligible for it if you didn't take the IRA distribution.
posted by small_ruminant at 10:40 AM on December 18, 2014

I can answer some of this. When I was in school, there was an obnoxious set-up with the retirement accounts whereby we were basically forced to either contribute more of our paychecks than most of us could afford, or withdraw the money every year (long story). Anyway, point being I had to withdraw the small (~$200) amount in the account every year.

You will have to pay at tax time, and the amount is a much bigger percentage than the rest of your income tax (and is calculated separately), because of the penalty. If you plug some estimated figures into Turbo tax, it should tell you.

Educational expenses are NOT things like housing and travel. The things that count are tuition, required books and supplies, and perhaps a few other things (you can get the full list via Google). But do not count on deducting living expenses just because you happen to be in school.

Anyway. Point being, the penalty still might be worth it, but be aware that you should stash a pretty significant chunk in a savings account and plan on paying it come tax time.
posted by rainbowbrite at 10:43 AM on December 18, 2014 [2 favorites]

Is there any reason you aren't investing the money in an IRA? It defaults to cash, but you should be able to put it towards some sort of mutual fund. I threw it into my Wolfram Investment App for stock only.

Random walk results says you should expect that 3 grand to be anywhere from 6-60 grand after 25 years.

Or, you could get 1500 now, and pay 1500 penalty. I'm trying to think of how bad a loan you'd have to get to pay 1500 in interest. Much less the 4.5k-58.5k in opportunity cost. Even taking out 35-45% in tax, keeping it in the IRA seems the better bet.
posted by politikitty at 10:48 AM on December 18, 2014 [3 favorites]

Start with the IRS publication on education deductions - Chapter 9 is all about the exemption for the IRA penalty and how to calculate it. It says room and board is allowed, up to a limit. Also, it shows how to calculate how much of an exemption you are entitled to take. My experience has only been in cases where r&B was paid to the university for on-campus housing. I might try calling the IRS helpline (maybe two different times - it is not always reliable advice) just to ask if off-campus housing expense is allowed.

TurboTax has a feature that lets you estimate your taxes for next year - you can use this to figure out the tax bracket for the incremental income.
posted by metahawk at 11:02 AM on December 18, 2014 [1 favorite]

Seconding politikitty. No loan will cost you $1500 in interest; tapping into your IRA is almost certainly a last-choice option, definitely behind a personal loan and likely also behind credit cards.
posted by samthemander at 11:20 AM on December 18, 2014

I think you'd be better off taking out a student loan than cashing this in. Have you checked to see whether you're eligible for a student loan, and what kind you're eligible for?
posted by mareli at 11:26 AM on December 18, 2014 [3 favorites]

Leave it, unless you have a real emergency. It will take days or maybe a week/week and a half to get that money out if you really need it. If you want it as a safety cusion, you are just as financially secure with the money *in* the IRA as you are with the money *out* of the IRA. If you're planning to use it for living expenses, etc., cashing out the IRA is marginally better than taking out a payday loan and probably worse than putting expenses on even a high-interest credit card. If you wouldn't put these expenses on a high-interest credit card, don't cash out the IRA to pay them.
posted by mskyle at 2:43 PM on December 18, 2014

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