Tax implications on cashing out a Lump Sum Pension?

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dct1970
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Joined: Fri Mar 13, 2015 2:54 pm

Tax implications on cashing out a Lump Sum Pension?

Post by dct1970 » Sat Mar 21, 2015 9:26 pm

How do the taxes and penalties work on cashing out a pension?

Here's my situation:
* A former employer is making my vested pension available to me later this year. Its only $55K. Since its a pension, it is "free money" to me.
* I owe $26K on my house and the payment is $600/month
* As of February i now have 3 children in preschool at a cost of about $2400/month
* Between my wife and I, we have about $700K in retirement thus far

The responsible thing to do, of course, is roll it over to an IRA. But a paid off house and $600 extra cash flow would be nice given the pre-school bill.

I want to understand how much I'd walk away with if I just took the cash.

I know there is a 10% penalty for early payout [I'm 45 years old]. Where I'm fuzzy is how it is taxed and any other fees/penalties. I think I understand the cash is just counted as regular income.

Our 2014 Taxable Income is just over $120K. I used the 2015 tax tables with an assumption of 3% increase in pay to estimate our 2015 tax bill will be about $22.6K. Then I added 55K to that estimated income and calculated that tax at $36.4K.

So would my "take home" amout be as follows?
55K
- 13.8 [i.e., 36.4 - 22.6]
----------
41.2
- 5.5 [i.e., 55K * 10%]
---------
35.7K

I that a fair estimate or am I missing something that would reduce my "take home" even more?

Thanks!

Wagnerjb
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Location: Houston, Texas

Re: Tax implications on cashing out a Lump Sum Pension?

Post by Wagnerjb » Sun Mar 22, 2015 10:51 am

Your calculations look right to me.

It you cash in the Lump Sum and spend it (even to reduce the mortgage) you are spending your retirement money today. Why do you necessarily pick this opportunity to steal from your retirement fund? At any time, you could take some of the $700K that you have in your retirement accounts and do the exact same thing. The tax cost would be identical if you took the funds from the $700k account. So I encourage you to resist the opportunity for mental accounting here....the $55K is no different than the $700K.

I would suggest that you think of this as if you have the full $750K in retirement funds. Now, what do you want to do? Do you want to take some of the retirement money and use it now? Most Bogleheads will cringe if they think you are spending those funds for current spending purposes (preschool). Most would probably be OK with the concept of paying off the mortgage, but they would point out that your source of funds is a very expensive one.

I think you have the math correct, the decision is yours.

Best wishes.
Andy

dct1970
Posts: 13
Joined: Fri Mar 13, 2015 2:54 pm

Re: Tax implications on cashing out a Lump Sum Pension?

Post by dct1970 » Sun Mar 22, 2015 1:57 pm

I've got a new Vanguard traditional Ira set up to receive the rollover. I was just doing the math to make sure I understand how it works. The only reason I even considered it was a) it is "free" money just given to me as opposed to investments I'd made and b) the immediate cash flow help it would provide. But you are right that I'd be stealing from the future for now. And there's no way I'd consider taking from the $700k to pay off the house.

Thanks!!

Sidney
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Joined: Thu Mar 08, 2007 6:06 pm

Re: Tax implications on cashing out a Lump Sum Pension?

Post by Sidney » Sun Mar 22, 2015 2:02 pm

dct1970 wrote:I've got a new Vanguard traditional Ira set up to receive the rollover. I was just doing the math to make sure I understand how it works. The only reason I even considered it was a) it is "free" money just given to me as opposed to investments I'd made and b) the immediate cash flow help it would provide. But you are right that I'd be stealing from the future for now. And there's no way I'd consider taking from the $700k to pay off the house.

Thanks!!
The $55K from the pension is no different than $55K from the $700K. Money is money, both were earned but simply sat in different places for a while. If you don't reach this conclusion, keep thinking about it until you do.
I always wanted to be a procrastinator.

dct1970
Posts: 13
Joined: Fri Mar 13, 2015 2:54 pm

Re: Tax implications on cashing out a Lump Sum Pension?

Post by dct1970 » Sun Mar 22, 2015 2:16 pm

I've got it. Money is money. I'm rolling it over. Thanks!!

retiredjg
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Re: Tax implications on cashing out a Lump Sum Pension?

Post by retiredjg » Sun Mar 22, 2015 2:17 pm

Putting it into IRA and leaving it for retirement is a sure thing.

But if you really want to get out from under the house, you could let the pension take the place of your 401k and/or IRA contributions for a year or two and put that money toward extra payments on the house. This way, there would be no 10% penalty and your house would be paid off earlier.

I'm not sure I like this idea. I'm just throwing it out in case you really want to pay off the house earlier.

Leeraar
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Re: Tax implications on cashing out a Lump Sum Pension?

Post by Leeraar » Sun Mar 22, 2015 2:21 pm

Roll it over to the IRA. It is always available then to do something silly with in the future. You don't have to decide now.

Seriously, get something like Bernstein's "The Ages of the Investor". Understand what your Human Capital is and where it should go.

If you think it's found money, by all means: Save a little less in the next few years, and use the excess from your income to pay down your mortgage.

L.
You can get what you want, or you can just get old. (Billy Joel, "Vienna")

cherijoh
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Location: Charlotte NC

Re: Tax implications on cashing out a Lump Sum Pension?

Post by cherijoh » Sun Mar 22, 2015 2:39 pm

dct1970 wrote: * A former employer is making my vested pension available to me later this year. Its only $55K. Since its a pension, it is "free money" to me.
I see from a later post that you have decided to roll it over into an IRA - that is absolutely the right decision.

But I want to disabuse you (and anyone else reading your post) that this is "free money". It isn't free - your former employer is converting a future liability they owe to you (so therefore a future benefit to which you are entitled) into a current payment. The pension may not have been on your radar, but the lump sum didn't just come out of nowhere.

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