Our third blog installment on the subject of 401(k) Rollover vs. Distribution concludes this week with focus on taking a Distribution from your retirement funds, what that means and whether or not this is a good move for you.
As mentioned in the first blog of this series, a 401(k) Rollover may not always be the best financial move for every person pursuing small business funding. And, even though Tenet Financial specializes in 401(k) Rollover Plans, we don’t advocate for 401(K) Rollovers for every single client in every single business scenario.
Let’s start at the top…a Distribution means you are literally “distributing” some or all of your retirement funds in a “cash out” manner. Your investment company sells off the stock you have for whatever the market value is that day and then they cut you a check. The money is yours to spend on whatever you choose, but some common uses are paying off credit cards, sending a kid to college, home repair/renovation/down payment or cash injection for starting a business or applying for a business loan.
Once the stocks are sold and the check is cut, and if it is before the age of 59 ½ years old, this is called taking a premature Distribution of your Individual Retirement Account (IRA). You now have to pay a penalty – generally 10 percent of the Distribution amount – for accessing these funds before the allowable age. On top of that 10 percent penalty, the monies are now included as part of your taxable income for that year and you will have to pay tax on that amount as part of that year’s earnings.
Consider this example: John Smith is opening a new service-based business with initial costs totaling $20,000. John has $15,000 in cash and he plans to withdraw $5,000 from his IRA. John will pay a $500 penalty (10 percent of $5,000) plus approximately $1000 (20 percent of $5,000) as taxable income. So, in all, John will pay $1,500 in penalties and taxes to take a Distribution and use these funds to start his new business.
In this example, it is clear that John’s $1,500 in penalties and taxes is less than the cost to do a 401(k) Rollover Plan for the $5,000 he needed to start his business.
Generally, people who have more liquid cash available to them outside of their retirement monies are in a better position to utilize funds from a Distribution because they are able to “cash out” a smaller amount and thus pay less fees and taxes. Another example of someone who can utilize a Distribution rather than a 401(k) Rollover would be someone whose retirement funds don’t qualify for 401(k) Rollovers.
If you have questions about 401(k) Rollover Plans, taking a distribution, or other small business funding needs, keep reading the Tenet Financial Group blog weekly or give us a call to discuss your specific situation – 1-888-901-3335, x. 9.