Rollover or throw it at Debt

[sellerse]

Hi there!

I've never posted here before... I stumbled across the site in a google search. I hope there are some sound financial minds out there willing to give their two-cents.

My question pins investing against paying off debt - I recently transitioned from being a HS teacher to an engineer. I taught HS for two years where I paid into the state's retirement plan. I now have to pull those funds out, and I have two options: (1) pull the funds out and use them to pay off my wife's student debt or (2) roll the funds over into my new company's 401(k). Choosing option (1) results in 30% being withheld for taxes (20% Federal, 10% penalty for withdrawal before age 59 1/2. Choosing option (2) results in not having to pay taxes now as long as I roll over 100%.

I've always been of the mindset that you can't start saving until you have zero debt. Right now, we pay $1200/mo to our student debt and I invest in my 401(k) just to get the company match.

To provide a little more context:

The funds in the teacher retirement plan are around $5000.
My wife's student debt is ~$24,000.
We have no debt except student loans - no credit card debt, no car payments.

Thanks for taking the time respond!

[kv968]

Actually you should have 3 options with the third being to roll it over into an IRA instead of your new employer's 401k. That would be option I'd take.

Paying down on the debt would great but paying 30% (technically what you're doing with cashing out) in order to do so doesn't make sense to me. I'd roll the $5k into a roll-over IRA at a company of your choice (Vanguard, T Rowe Price, etc...) and just tackle the student loans with what you have.

[Randomsaver]

My devalued $1 cent is :

Investments are not certain cash inflow (especially nowadays!). Debt reduction is, in the sense that you reduce interest payments. Once you're done with debts then go full blast on investments (which is really gambling - things can go bankrupt).

Re your concern of tax, to me, no one escapes it. It's either you pay it now, or you roll it over and let it grow bigger for Uncle Sam to take from you in the future.

[creditcardfree]

I vote for rollover. I'm of the mindset that once you have put money away for retirement you don't touch it until retirement. And you will never regret it. You will have more choices if you rollover into an outside investment than into a new 401k, which may have limited options and higher fees.

It seems you have the ability to keep making payments on the debt, therefore no reason to use the money to pay off debt.

[snafu]

my .02 cents...Retirement money is for retirement in the future and needs all the years in your future to compound into serious value. You need to know what your new employer's plan offers, expenses, fees, Management Expense Ratio [MER] to make an intelligent decision. BTW, I hope you have joined your employer's retirement plan at minimum to grab any match as it is Free Money.

I agree with your mindset that getting debt like wife's SL paid down is important however, I wonder if you have an Emergency Fund. It's that sum that takes care of things that unexpectedly goes awry. If not, I suggest you start some small plan to squirrel away a minimum $ 1,000. Drop change in a big jar daily, find items you don't use, don't need and sell on local FB seller, CraigsList or yard sale, work overtime, or take a short term 2nd job part time for example.

If you're serius about ridding yourself of debt, perhaps we can help. Do you know where your money goes? Does every dollar have a 'job?' What percentage of your household net income go to needs? What percentage is used for 'wants?'

[doingitallwrong]

I agree with rolling it over into an IRA (Fidelity or Schwab are other low-cost options). Not only are you paying federal income tax and a penalty if you use the money to pay off student loans, but you'll also have to pay state income tax (if you live in a state that has income tax) and you're losing years (decades?) of tax-deferred compound interest on that $5000. It really does add up over time.

You don't mention your student loan interest rate, although I'm not sure that would make a difference. For me, it might if the SL interest rate was high and you could pay off the whole thing at once, but knocking $5000 off the total at the rate you're paying it off probably won't make a huge difference in the long run. Using very rough calculations, and using a SWAG of 7% interest, you're on track to pay off the student loan within two years, and you'll pay about $1400 in interest over that time. If you put the $5000 toward the loan now, it will take you 17 months to pay it off and you'll save about $600 in interest. Since it will cost you $500 just in tax penalties to use the $5000 now, that's really only a $100 savings. Odds are very very good that the return you'll see from leaving the money in an IRA will far outstrip $100.

(And actually, it will be a little longer and save a little less, because I used the full $5000 instead of the $3500 you'd net, so it will end up costing you about $200 (tax penalty minus interest savings) to use the $5000 now.)

[feh]

I've always been of the mindset that you can't start saving until you have zero debt.

Could you explain why? I don't see how this is true.

Don't cash out your retirement plan. Roll it over.

[Petunia 100]

Hi there!

I've never posted here before... I stumbled across the site in a google search. I hope there are some sound financial minds out there willing to give their two-cents.

My question pins investing against paying off debt - I recently transitioned from being a HS teacher to an engineer. I taught HS for two years where I paid into the state's retirement plan. I now have to pull those funds out, and I have two options: (1) pull the funds out and use them to pay off my wife's student debt or (2) roll the funds over into my new company's 401(k). Choosing option (1) results in 30% being withheld for taxes (20% Federal, 10% penalty for withdrawal before age 59 1/2. Choosing option (2) results in not having to pay taxes now as long as I roll over 100%.

I've always been of the mindset that you can't start saving until you have zero debt. Right now, we pay $1200/mo to our student debt and I invest in my 401(k) just to get the company match.

To provide a little more context:

The funds in the teacher retirement plan are around $5000.
My wife's student debt is ~$24,000.
We have no debt except student loans - no credit card debt, no car payments.

Thanks for taking the time respond!

I wouldn't choose either of those options. Instead, I would open a traditional IRA at Vanguard and roll the money there. Choose the Target Retirement Fund which most closely coincides with either your expected retirement year or your desired asset allocation.

BTW, the mandatory 20% withholding is just that, withholding. The actual tax and penalty due will be calculated when you prepare your 2014 income tax return. The withholding may not cover the amount due. Additionally, your state may want some income tax and penalty too.

[moneysma]

I wouldn't choose either of those options. Instead, I would open a traditional IRA at Vanguard and roll the money there. Choose the Target Retirement Fund which most closely coincides with either your expected retirement year or your desired asset allocation.

BTW, the mandatory 20% withholding is just that, withholding. The actual tax and penalty due will be calculated when you prepare your 2014 income tax return. The withholding may not cover the amount due. Additionally, your state may want some income tax and penalty too.

I agree with this 100%. If you are in a higher tax bracket than 20%, you are paying more tax than you think, plus whatever your state hits you with, if they do.

With just $5K in the plan, taking a 30% hit leaves you with $3500. The student loans are over $20K so it's not like you can wipe out the debt doing this.

I'd just roll it into an IRA and concentrate on paying down the student loan debt.