Tax Tip: Don’t Touch 401(k) Funds!
Q. I recently got a new job. My previous employer offered a 401(k) plan; my new employer does not. What should I do with the money from my old 401(k) plan when the funds are disbursed? Is there anything I can do to defer paying taxes on the money? --A.W .
A. To avoid immediate taxation, you should transfer the proceeds in your old employer’s 401(k) plan to a tax-deferred individual retirement account. Those proceeds and the accumulated interest will be taxable when you withdraw them.
The transfer from the 401(k) plan to the IRA must be made in strict accordance with federal regulations. Under rules effective last year, taxpayers cashing out of a former employer’s 401(k) or other qualified pension plan must have that money transferred directly--trustee to trustee--to a qualified IRA. If the taxpayer takes possession of the money--even to make the transfer--he will be slapped with 20% withholding on the disbursement. Even if the taxpayer puts the pension money in an IRA himself within the allowed 60 days, the 20% tax still applies.
To repeat: To avoid the tax, you must not take possession of the money. Rather, have the trustee of your 401(k) plan transfer it directly to the trustee of the IRA you establish for the funds. This isn’t hard, but it does require planning.
Equity May Improve Mortgage Eligibility
Q. My father recently died and left his home to my brother and me. I would like to buy my brother’s half from him but don’t have enough cash. How can I get a loan? I am a renter now and want to move into the house. --R.C.M .
A. Although you could certainly approach any commercial mortgage lender, your best bet may be to ask your brother to carry the note. After you and he agree on a purchase price, loan terms and interest rate, you would simply pay him every month just as though you were paying rent. Of course, you would need to have the appropriate documents executed and recorded, clearly delineating the scope and terms of the purchase and loan.
If your brother wants his cash now, you will be forced to seek a commercial loan. But because you already own 50% of the home, you should be asking for a “cash-out refinancing.” And because you already have 50% equity in the property, you should find many large mortgage lenders inclined to relax the usual income qualifying standard. Because you are purchasing only half the house, the most you would need to borrow would be 50% of its fair market value.
Consider the following examples from Countrywide Funding, the nation’s largest mortgage maker: A borrower is seeking a 30-year, fixed-rate loan of $78,000 at 7.25%. With just a 20% equity stake in the home, he would need a monthly income of $2,500 to qualify for the loan. However, if the borrower already owns 50% of the home, has an unblemished credit history and no other outstanding consumer debt, he could get the loan while earning as little as $1,800 to $2,000 a month.
Of course, there are no guarantees here. Most lenders will not make a loan if housing costs--including principal, interest, taxes and insurance--exceed 36% of the borrower’s income. The adage that equity does not repay a loan still applies. You must have sufficient income to show a lender you can repay the loan and still have enough left over to cover living expenses.
Thrift Takeover Rules Allow Rates to Be Cut
Q. Several years ago, we put $99,000 into a certificate of deposit with a local savings and loan that promised to pay 9.25% interest for five years. Halfway into the term, the thrift collapsed and was taken over by the government. Another S&L; took over operations and immediately cut the interest rate on our CD to 4.58%. Is there anything we can do about it? We thought we had a contract. --W.C.W .
A. In order to entice healthy thrift institutions to take over ailing ones, the Resolution Trust Corp. allows the acquiring thrift to lower the interest it pays on depositors’ accounts to match current rates.
Why? Most ailing institutions were paying interest far above prevailing rates in order to attract deposits. This trapped them in a vicious circle of having to attract new money in order to cover their obligations to existing depositors. In an effort to break the cycle, the RTC allows thrifts taking over ailing institutions to bring depositor interest rates back into line with prevailing market conditions. In fact, the RTC allows them to pay as little as the prevailing savings passbook rate on assumed deposits.
If it is any consolation, there are thousands of depositors just like you, forced to pay for the sins of high-flying thrift operators who stumbled and took their institutions down with them.
By the way, in case you are wondering, you are not allowed to deduct the interest you would have earned if your account had not been assumed as an investment loss.
We’ve been asked this question before and had to remind readers that you can’t deduct something you never had.
Settlement Excluded From Taxable Income
Q. I am 75 years old and drawing Social Security. Last year, I received a wrongful-death settlement from the owners of the nursing home where my mother fell to her death from a fourth-floor window. Must I include this settlement in my modified adjusted gross income for calculating the taxable portion of our Social Security benefits? -- H.S.F .
A. Insurance settlements of the type you describe are not subject to income tax and are not included in gross income when calculating the taxable portion of Social Security benefits.
