Should we take (small) early withdrawal penalty?

[PS241]

I have a fairly trivial question with respect to the amount of money affected, but thought I would check with the forum to see if I am missing something obvious. My wife recently quit her job to be a stay at home mom. She was enrolled in the company 401k but never had any matching funds vested. Her 401k balance is around $750 with a whopping $30 investment gain.

I am contributing 7% plus 3% employer matching to my 401k. We are currently working on building our emergency fund with a goal of six months expenses. We are currently at 5 months and plan to max my Roth IRA when finished with emergency fund. I was originally thinking of rolling her 401k to an IRA at vanguard, but she is below the fund minimum and I am not sure I want to deal with the hassle of this small account laying around. My understanding is that an early withdrawal would have a 10% penalty plus state and federal taxes taken out.

Age : 24
Debt: None besides mortgage.
Emergency fund: 5 months
Tax status: Married filing jointly
Federal tax: 15%
State tax: 7%
Residence: IA

Question:
Should we take early withdrawal for a fee of $75 plus tax to maintain simplicity? Am I missing anything with early withdrawal penalty?

[livesoft]

No you shouldn't. Instead of contributing to your Roth IRA, just contribute the same amount to her Roth IRA, then rollover her 401(k) to her Roth IRA.

[pkcrafter]

I agree, don't withdraw, open a spousal Roth for your wife if she doesn't have one and roll the 401k into it.

Paul

[BL]

You could put (at least) $1000 into a her spousal tIRA account so she could rollover her 401k. Any Target Retirement or the Star fund would work. Then convert to her Roth IRA or maybe keep in tIRA if eligible for tax deduction. Never pay the penalty if possible to avoid it.

[CABob]

Another vote for rolling it over rather than taking the money out. Even if you can't open the IRA where you would prefer to have it you could put it into a money market or CD at a bank or credit union until you can move it to a more desireable institution and investment.

[BL]

Another vote for rolling it over rather than taking the money out. Even if you can't open the IRA where you would prefer to have it you could put it into a money market or CD at a bank or credit union until you can move it to a more desireable institution and investment.

Excellent idea. Check with your bank and see if they would do an IRA with the funds as a CD or whatever. If so this might be the simplest idea yet. Even if you have to add $250 to bring it up to $1000, it would be worth it.

[Bob's not my name]

a fee of $75 plus tax to maintain simplicity?

I don't see why you'd throw away a third of the money for "simplicity" while simultaneously paying 22% tax on your Roth IRA contributions. Taking money out of an IRA while simultaneously putting money into an IRA and getting taxed in both directions doesn't sound like simplicity to me. Put another $2,250 into her TIRA -- this is equivalent to $1,750 in your post-tax Roth IRA. Then she'll have the minimum for most Vanguard funds, and so will you.

Compare:

$3,000 in her TIRA
$3,250 in your Roth IRA (= $5,500 maximum minus $1,750 minus the $500 you could have had from liquidating her 401k)
Total tax: $920 on your Roth IRA contribution
Total gross salary used: $2,250 + $4,167 = $6,417

or the "simplicity" option:

$0 in her TIRA
$5,500 in your Roth IRA ($500 from her eviscerated TIRA, $5,000 from income)
Total tax and penalties: $1,660
Total gross salary used: $6,410

So you're thinking about paying more tax to have less savings.

By the way, in your state taxpayers 55 or older can exclude $6,000 each of IRA conversions. 15% federal tax is a low rate, but paying a state tax now that you might avoid in the future makes the Roth choice a little shakier.

[camaro327]

With your 15% + 7% middling tax bracket you have two good options which have been mentioned:

1. Roll the money to a Roth IRA and pay the small conversion tax (no penalty) and add at least enough to get into the Star Fund (min 1,000).

2. Or you can keep it as traditional and add $250 that way to get to the Star Fund minimum.

CD at a bank is an option to, but they can always charge fees (if not now in the future) which would eat into the return on the initial amount.

Your Federal bracket leans towards the Roth option #1; however your state tax is high enough to make #2 a viable alternative.

[PS241]

Thanks for the replies everyone. The math in Bob's not my name is especially helpful. I've already got an account at vanguard with my Roth IRA (just haven't funded any this year) and I was trying to irrationally justify throwing away money to not have to deal with an account we won't likely have the money to add to for sometime.