Every once in a while, a sweet little cash angel may drop an unexpected gift in your lap. Sometimes it’s just $20 from a coat pocket, or a crisp $100 bill laying on the ground (this actually happened to me). But if you’re lucky, it turns out to be a whole lot more than that.
On Monday we received a letter in the mail. It was from Kodak, my husband’s former employer, asking if he wanted to cash out his pension benefit. It’s not a large pension, but it would have provided a fixed $6,600 annual payment once he turned 65. Now they want to cash us out with a lump sum.
Turns out we have 3 options:
- Take the lump sum in cash (which means a 20% tax withholding and a 10% early withdrawal penalty)
- Receive the annuity as originally intended
- Take the lump sum and roll it directly over to another qualified retirement plan (no tax withholding or penalties)
So how much is this unexpected chunk of money they’re offering?
And with unexpected chunks of money, come decisions.
Take the lump sum in cash? No way. Uncle Sam will take 20% in taxes right off the top, as well as a 10% early withdrawal penalty because Randy is not at least 59 ½. (And… we could still have a huge bill come tax time depending on which tax bracket that extra cash pushes us into. Ack.)
Leave things as they are and just receive a monthly check? No thanks. We can invest the entire lump sum ourselves, and get a better return than if we took the monthly annuity option. So that leaves us with…
Roll over the entire lump sum into another qualified retirement plan? Yes, please.
We don’t want a single cent to go to Uncle Sam…yet. We want every dollar working for us, growing over time. When it’s time to withdraw, the government will get their cut. But for now, we want tax-free growth.
And in order to accept the lump sum without that tax withholding or the early withdrawal penalty, it must be transferred to another tax-deferred plan such as a Traditional IRA or a 401k.
Traditional IRA or Randy’s current employer 401k?
If we roll it over to a Traditional IRA, we can’t make (penalty-free) withdrawals until he turns 59 ½, but the IRA will allow us access to all of the low-fee index funds we want to invest in. If we roll it over to his 401k, he can withdraw the money beginning the year he turns 55, but our investment options are limited to only those his employer offers.
So…drum roll…we’re going to take the lump sum and roll it over to a Traditional IRA.
We’ll have enough saved in other accessible accounts when we begin our early retirement that we shouldn’t need to access this money (or the money it generates) until after he turns 59 ½. So we’ll open a Traditional IRA, invest the cash in solid index funds and let it marinate for a while.
The decision, for us, was fairly easy. We looked at each scenario logically, and determined that we would get the most benefit from rolling it into a Traditional IRA.
Why I Am Telling You This Less-Than-Fascinating Tidbit of Our Life
As I said, the decision for us was pretty easy. A little bit of math and a long-term wealth-building outlook, and we had our answer.
But the sad truth is that for others who find themselves with a lump sum of cash, the decision is made with emotions, not logic. They don’t have the luxury of sitting back and deciding how this windfall could benefit them long-term. They can’t see beyond next week, let alone 5…10…20 years from now.
When your financial life is in chaos, you just take the cash (and the 30% tax/penalty hit) and run. Maybe there’s unpaid credit card bills, or you’re behind on your mortgage. So you cash out to get yourself back above water. Or worse, you see a big shiny car/boat/thing-a-ma-jiggy that has your name on it.
(Now, just so I’m clear, if you’ve got debt, and your intent is to pay it down and become debt-free, then cashing out and paying it down (or off!) is the best thing you can do.)
But my real point is that when your financial life is in order, you can make the decision using logic, allowing that windfall to really work for you.
A jumpstart towards building wealth.
So don’t wait and hope for a windfall to rescue you from your money troubles. Get (or stay) debt-free now, so that if/when the sweet little cash angel drops a windfall in your lap, you can use it to really build wealth and be ahead of the game.
P.S. Remember that $100 bill I found? I was 18 years old, on vacation in Hawaii. I was walking down a path to the beach at Hanauma Bay, and there it was, a fresh $100 bill just lying on the ground. Not a soul was in sight, so I picked it up and stuffed it in my beach bag, with a grin a mile wide.
Fast forward to a few months ago, and I’m telling the story to my son. With a look of excitement, he asked if I still had the $100 bill. I told him, no, of course not, that was almost 20 years ago. Then he stomped off and pouted, mad that I had spent it. It was kinda funny, but I have to say I agree with him. Sigh.