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Posted by blwolcha on December 8, 2006, 2:26 am
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Hi, I find myself sometimes thinking that there's a way to
realize a short-term gain (over one's given compensation)
from a 401k contribution, even including the early withdraw
penalty, and I'm wondering if my thinking is correct. The
question comes down to, does the "free money" obtained by an
employer match ever more than offset the penalty assessed
for an early withdrawal from a 401k plan?
For starters, assume that, hypothetically, someone had no
interest in saving for retirement (just grant the assumption
whether or not it's prudent). Assume an annual income of
$100,000 with the employer matching 50% of up to 10% of
one's income. And for simplicity, assume immediate full
vesting of the employer match, and ignore any cap
gains/losses in the 401k. Now consider:
Case 1 (no 401k contribution): Taxable income is $100,000
Case 2 (10% 401k contribution): Employer match is $5,000, so
401k acct at end of year is $15,000. Full withdrawal leaves
taxable income of the year at $105,000, plus you lose $1,500
(10% of $15,000) after taxes as a penalty.
Now what's the difference in taxes on an extra $5,000
income? Even if you assume the high 35% rate, that's only an
extra $1,750 you owe in taxes. But $5,000 > $1,750 + $1,500,
so it seems like Case 2 is the better scenario for the
person determined not to save for retirement.
Can this be right? And more generally, since employer
matches vary widely, what level of an employer match is
required to tip the scales in favor of the hypothetical Case
2? Thanks for helping me think through this!
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Posted by Phil Marti on December 8, 2006, 3:23 pm
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> Hi, I find myself sometimes thinking that there's a way to
> realize a short-term gain (over one's given compensation)
> from a 401k contribution, even including the early withdraw
> penalty, and I'm wondering if my thinking is correct.
Probably not. Save yourself some time and check your plan's
rules. I doubt that you'll find easy access to your account
while you're still working.
--
Phil Marti
Clarksburg, MD
<< ======================================================= >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2006) - All rights reserved. >>
<< ======================================================= >>
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Posted by joetaxpayer on December 9, 2006, 6:42 am
Please log in for more thread options blwolcha@hotmail.com wrote:
> Hi, I find myself sometimes thinking that there's a way to
> realize a short-term gain (over one's given compensation)
> from a 401k contribution, even including the early withdraw
> penalty, and I'm wondering if my thinking is correct. The
> question comes down to, does the "free money" obtained by an
> employer match ever more than offset the penalty assessed
> for an early withdrawal from a 401k plan?
The tax is a wash, a match to negate the 10% penalty is
enough. An 11% match will negate a 10% penalty, and is the
breakeven. The real question is, what employer would allow
annual withdrawals from the 401(k)? They all have hardship
provisions that disallow this strategy.
JOE
<< ======================================================= >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2006) - All rights reserved. >>
<< ======================================================= >>
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Posted by blwolcha on December 12, 2006, 2:34 am
Please log in for more thread options joetaxpayer wrote:
> blwolcha@hotmail.com wrote:
>> Hi, I find myself sometimes thinking that there's a way to
>> realize a short-term gain (over one's given compensation)
>> from a 401k contribution, even including the early withdraw
>> penalty, and I'm wondering if my thinking is correct. The
>> question comes down to, does the "free money" obtained by an
>> employer match ever more than offset the penalty assessed
>> for an early withdrawal from a 401k plan?
> The tax is a wash, a match to negate the 10% penalty is
> enough. An 11% match will negate a 10% penalty, and is the
> breakeven. The real question is, what employer would allow
> annual withdrawals from the 401(k)? They all have hardship
> provisions that disallow this strategy.
Thanks, but I really don't understand. Can you comment in
terms of the example I give in my original post? There I
describe a situation where a 5% match seems to well make up
for the 10% penalty and the tax. Where have I gone wrong in
the details?
<< ======================================================= >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2006) - All rights reserved. >>
<< ======================================================= >>
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Posted by joetaxpayer on December 13, 2006, 10:57 pm
Please log in for more thread options blwolcha@hotmail.com wrote:
> joetaxpayer wrote:
>> The tax is a wash, a match to negate the 10% penalty is
>> enough. An 11% match will negate a 10% penalty, and is the
>> breakeven. The real question is, what employer would allow
>> annual withdrawals from the 401(k)? They all have hardship
>> provisions that disallow this strategy.
> Thanks, but I really don't understand. Can you comment in
> terms of the example I give in my original post? There I
> describe a situation where a 5% match seems to well make up
> for the 10% penalty and the tax. Where have I gone wrong in
> the details?
Forget taxes for a moment. Zero tax in and out.
You deposit $100, and get $11 match. You withdraw the money,
and on $111, pay $11 in penalty. My only point was a 10%
penalty is overcome by a low match.
If the first 5% is matched dollar for dollar, well, on $100,
you'd have $200 after match and net $180.
Add in the tax, and at 25% tax rate, you're down to $130,
but still ahead. But the employer will not allow this.
JOE
<< ======================================================= >>
<< The foregoing was not intended or written to be used, >>
<< nor can it used, for the purpose of avoiding penalties >>
<< that may be imposed upon the taxpayer. >>
<< >>
<< The Charter and the Guidelines for submitting posts >>
<< to this newsgroup as well as our anti-spamming policy >>
<< are at www.asktax.org. >>
<< Copyright (2006) - All rights reserved. >>
<< ======================================================= >>
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