Today is my last day at a large corporation. I am leaving to start a business at the age of 40. I have been a good saver and have a 401(k) and a Cash Balance Plan. I am going to rollover my 401(k) to an IRA with Vanguard. A coworker told me I can take out part or all of the Cash Balance Plan without a 10% penalty. Is this true? I know it will be taxable. What are my options? Rollover to an IRA? Take out with penalty and tax? Take out with tax only (no penalty)? Thank you.
I agree with Erik above. I am guessing that your coworker was age 55+. You could roll the cash balance in with your Vanguard IRA (or do a separate IRA) and consider a 72(t) distribution to pull dollars out and avoid the 10% penalty if you could use the cash flow. See your tax advisor and financial advisor to discuss how that works.
Congratulations on your new venture and I wish you much success. I also commend you on being a good saver. As for taking a distribution from your cash balance plan, your co-worker is not correct about the penalty being waived. That only applies if you are 59 1/2 years of age or older. Based on your age there would be a 10% early withdrawal penalty in addition to taxes. The only exceptions to the 10% early withdrawal penalty on taxable distributions for someone under the age of 59 1/2 are death, disability, divorce, annuity payments over expected lifetime, Roth conversions, IRS levy, return of excess contributions or age 55 with separation from service. Your best option is to rollover to an IRA and continue saving.
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No, if you receive a distribution of your Cash Balance account before age 55, and you do not roll it over, you will have to pay ordinary income tax on your distribution and an additional 10% excise tax for early withdrawal (unless you qualify for an exception).
I think your coworker may be confusing distributions made to a beneficiary or an alternate payee in the event of your death. The 10% early withdrawal penalty would not apply in that case, but you're still very much alive!
Rebecca, a Cash Balance Plan is a Defined Benefit Plan that has distribution characteristics similar to those of a Defined Contribution Plan. Typically on a Defined Benefit Plan, you cannot withdraw your money. But with a Cash Balance Plan, you can withdraw your vested amount in full only, you cannot make a partial withdrawal. You will be subject to taxes as ordinary income plus the 10% penalty.
It might make sense for you to roll it into an IRA, then withdraw what you need only if you really need it. The plus to an IRA is that you can select your universe of investment choices, have some control over fees, and have administrative control over how much and when you make a withdrawal. Taxes and penalties on distributions will apply to 59 ½ in an IRA, whereas taxes and penalties will apply on a Cash Balance plan until age 55; then you just pay tax as ordinary income.
Though it may not be relevant to your needs, what you would lose by taking it out of a Cash Balance plan is an actuarial guarantee that is insured by a federal agency, the Pension Benefit Guaranty Corporation (PBGC). If a defined benefit plan is terminated with insufficient funds to pay all promised benefits, the PBGC has authority to assume trusteeship of the plan and to begin to pay pension benefits up to the limits set by law. Defined contribution plans, including 401(k) plans, are not insured by the PBGC. Please review my Financial Guide on Cash Balance Plans https://www.brightscope.com/financial-planning/advice/guide/5901/What-Is-A-Cash-Balance-Plan/