Rollover or lump sum withdrawal?

[brandino29]

Relatively new reader, first time poster, so apologies if similar topics have been discussed before....

I recently changed jobs from local government with a pension to an out of system non-profit.  I was in my gov't position for 4 years, and I'm not fully vested in the pension plan but I do have around $7,200 of my own contributions sitting there and I'm in a bind about what to do with the balance.  The way I see it, I have basically 3 options:

Option 1
Withdraw it all in a lump sum.  If I do this, I'll take a hit of 20% upfront in federal taxes, a 10% excise tax penalty for early withdrawal when I file this year's taxes, and state income taxes next year (about 4.5%).  So in all, my $7,200 would be a lump sum payment of about $4,716.  We don't carry a credit card balance and we're just about to pay off our car (I know I know, we financed it but that was before I became a mustachian).  So I could put it toward our mortgage (remaining balance of $68,000 at 3.5% interest) or invest it into a dividend or index fund (although I'm a bit worried the market is overvalued at the moment and I wouldn't be getting the best deal, dollar cost speaking).

Option 2
Rollover into an IRA tax free.  The problem here is that my new employer only offers a SIMPLE IRA and my understanding of the SIMPLE IRA is that there are a lot of restrictions on rollovers and can only be done from/to another SIMPLE IRA.  That would mean I'd need to open up a new IRA, either Roth or Traditional (I suppose? I haven't really explored this option yet). 

Option 3
Do nothing.  I leave my money sitting there where the state guarantees to earn a flat 4% per year indefinitely.  After I turn 55 (currently I'm 29) I could withdraw it without the 10% penalty.  Running the amount through the Motley Fool investment calculator though and estimating 2% inflation, my investment would be worth all of $8,873 in 26 years.  And I'd still be on the hook for the federal and state taxes if I understand it correctly. 


Unless there's a better argument or something I'm missing about Option 3, I'm essentially taking that one off the table.  Personally, I'm partial to putting it into a dividend fund, expecting that the market over the next 25+ years will outperform the 3.5% I'd save on my mortgage or the 4% I'd earn leaving it where it is, and hopefully would more than make up for the tax hit and penalty.  I lean away from the rollover option simply because it "locks up" my money for many years and we have aspirations of buying rental or commercial properties down the road.

Many thanks in advance for your thoughts!

brandino29
Aspiring mustachian

[matchewed]

IMO roll over to a traditional IRA. You don't get hit on taxes and you'll probably earn more than 4%.

If you're worried that the market is overvalued you are letting fear dictate your choice. The best time to invest is now, the second best time was yesterday, this is regardless of the actual day to day price of the markets.

If you want to buy property down the road then start saving for it. You've stated this want in rather nebulous terms so how much of a plan do you have in place? How much further will this money help you in this plan? If you can't define those things you shouldn't be paying penalties now on money you don't know if you can use or not.

[Catbert]

Roll it  over to a traditional IRA.  Go to Vanguard or Fidelity or brokerage house of your choice and they can help you do the rollover.  You want it to go directly to the new IRA custodian.  If the check is made out to you your old employer will likely take out 20% for taxes.  Then you'll have to make up the 20% or pay taxes/penalties on it.

[tylerherman]

Your employer has nothing to do with your IRA. You can get it anywhere and through anyone. That is where the money should go. Unless you'd rather roll it into an existing or new 401(k). Either is better than getting hit for 20%.

[Eric]

Your employer has nothing to do with your IRA. You can get it anywhere and through anyone. That is where the money should go. Unless you'd rather roll it into an existing or new 401(k). Either is better than getting hit for 20%.

This is spot on.  Whatever you do, don't take the lump sum.  That's throwing good money down the drain.  You can open an account for free at any investment website and roll it into an IRA there.  Then invest it however you choose.  (index funds are great and easy)

[brandino29]

I appreciate the responses.  I definitely would hate to take the hit on the penalty and taxes but it's enticing to have a potential lump sum payment there to invest into my brokerage account that's not gotten nearly the amount of attention (i.e. money) that I'd like. 

I spent a few minutes trying to break down the IRA aspect.  The 'problem' is that coming from the public sector I have a 457(b) in lieu of a 401(k) that I can't continue to contribute to and the only retirement plan my new employer, a small non-profit, offers is a SIMPLE IRA which appears to be quite unique in the IRA world.  I can't rollover the pension of 457(b) funds into a SIMPLE.  So I'd have to open a new one outside of my employer plan, which is fine by me to have another retirement account but I was having difficulty understanding the tax implications of having both a SIMPLE IRA and a traditional IRA in regards to contribution and deduction limits. 

[matchewed]

There won't be any tax implications for a roll over and it won't affect your contribution limits if you roll to an IRA.

http://www.irs.gov/Retirement-Plans/Plan-Participant,-Employee/Retirement-Topics---Rollovers-of-Retirement-Plan-Distributions

Your pension is considered a defined benefit plan.

Why pay all the taxes and penalties just to invest it in something you can invest it in without those fees and penalties? You shouldn't be investing in your different taxable or not taxable accounts because you "like" them. Take advantage of tax deferred investment. Your future you will thank you.

[brandino29]

Why pay all the taxes and penalties just to invest it in something you can invest it in without those fees and penalties? You shouldn't be investing in your different taxable or not taxable accounts because you "like" them. Take advantage of tax deferred investment. Your future you will thank you.

So deep down I agree, I guess I was just hoping someone out there would help me rationalize taking the lump sum because who doesn't love suddenly having $5,000 in hand? 

Just to clarify, my concern about tax implications isn't about the rollover itself, but proceeding with two IRAs.  The SIMPLE has a 12,000 pre tax, annual contribution limit, from what I gather a traditional IRA has a pretax 5,000 annual contribution limit, but it's not clear to me if I can get the tax deduction of $12k on the SIMPLE AND the $5k of traditional IRA, or if it's even permissible to contribute that much with two accounts. 

[matchewed]

So that tax benefit is from your earned income as you are contributing.

Since you've already contributed to your rollover it doesn't count. If you want to continue to contribute to your new IRA you should have no limitations, but I am not an expert. Give this a read - http://www.irs.gov/publications/p590/ch01.html#en_US_2011_publink1000230554

And you can actually contact the IRS with questions - http://www.irs.gov/Retirement-Plans/Employee-Plans-Customer-Account-Services