Excuse me if I'm repeating myself.
But the longer I write this column, the more I find common themes and issues among the questions readers pose to me. Favorite topics include retirement plan rules, Social Security, student loans and other forms of debt.
That tells me there are some issues I can never discuss enough and is the reason the questions and answers below may sound familiar if you read this column on a regular basis.
Q: I am a 26-year-old female. I was laid off by my current employer. My 403(b) is still at the company and I am in the process of turning it over to a mutual fund at my bank. My question before I do this is: Will it benefit me to take the $7,000 I have saved in the retirement fund and pay a student loan that I have currently in repayment? I am trying to get the loans put on hold due to unemployment but it has been taking some time and I can no longer afford the monthly payments.
- A.C., Trumbull, Conn.
A: The short answer is no, A.C. Pulling the money from your retirement savings to pay down the student loan will not benefit you. In fact, it will cost you more than you could imagine.
The reason is the taxes and penalties you would pay on the $7,000 withdrawal from the 403(b) plan are likely to exceed the savings on interest charges you would realize by paying down the loan. By my calculation, that $7,000 withdrawal would likely cost $2,100 in taxes and penalties.
Early Retirement Withdrawals: Stiff Tax Penalty
That $2,100 figure assumes you are in the 15 percent federal tax bracket and the 5 percent Connecticut state tax bracket and that you would be paying to the IRS a 10 percent early withdrawal penalty.
And you would need to come up with that $2,100 when you file next year's tax return if you elected to have no taxes withheld from the payment. If you're still unemployed next April, where is that money going to come from?
One other thing to keep in mind: The eventual savings on interest charges stemming from early repayment of the student loan are unlikely to be as great as you think. Student-loan interest is deductible up until you reach higher income levels.
That means a 6.8 percent rate loan (the current rate for unsubsidized Stafford loans) may be costing you just 5.78 percent, again assuming you are in the 15 percent federal tax bracket.
Finally, there is an opportunity cost to yanking out the $7,000 you've accumulated in retirement savings. The greatest advantage a young investor like you has is time, which turbo charges the power of compounding. Once lost, that time – and the potential earnings – can never be regained.
Now that I've told you what not to do, let me suggest a different course of action.
First, I would persist with your efforts to obtain a deferment on payments while you remain unemployed. Keep calling your student-loan lender until you get a satisfactory answer. Don't let them off the hook easily.
While you await an answer, squeeze your budget as much as possible to make payments.
If you decide it's absolutely necessary to draw from your retirement savings, then transfer the 403(b) to a rollover IRA and then withdraw only the amount needed to make a particular month's payment. Better to pay taxes and penalties on a $200 early withdrawal rather than the full $7,000.
One more thing: I'd consider moving the 403(b) funds into a rollover IRA at a low-cost, online broker rather than a bank-sold mutual fund, which is likely to be more costly.
Contributing to 401(k) After Age 70
Q: I turned 70 June 16, 2009. I own my own company and still work here. My question is should I continue contributions to our 401(k), and must I take payments from my 401(k) on April 1, 2010?
- V.C., Bellmawr, N.J.
A: Unless you need the money, V.C., there's no reason to stop contributing to your 401(k) plan. There's no age limit on contributing to an employer-sponsored retirement plan as long as you continue to work and collect a paycheck.
Any amount you contribute will be shielded from federal and state taxes and will enjoy the benefits of tax-deferred growth.
As a business owner, however, you will be unable to avoid begin making required minimum distributions from your 401(k) account. IRS rules do allow individuals who continue to work to delay their required withdrawals while still employed if their particular plan rules allow it.
But there's one exception to that rule that applies to you, V.C.
The IRS says that anyone who owns a 5 percent or greater share of the business sponsoring the 401(k) plan may not wait to take their required minimum distributions beyond the usual deadline. As you correctly note, the normal deadline for taking the first distribution is April 1 of the year after reaching age 70½.
Assuming you own at least 5 percent of your business, that means, V.C., you in fact will need to take a required distribution next year. But that doesn't mean you should stop contributing to your company's 401(k) plan.
Most likely, the amount you are required to withdraw from the plan will be small compared to what you will be able to contribute (currently $22,000 for someone over age 50).
So my advice is max out your contributions, withdraw what you must and continue to accumulate savings until you decide you're ready to enjoy a well-deserved retirement.
This work is the opinion of the columnist and in no way reflects the opinion of ABC News.
David McPherson is founder and principal of Four Ponds Financial Planning in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at firstname.lastname@example.org.