severance pay to a 401(k)
I'm about to receive a lump sum severance payment
for being laid off through an acquisition. I have another job already
and had planned on using the bulk of the money as a down payment
on a home (condo). Can I direct a portion of the severance to my
401(k)? I don't have access to a 401(k) in my new job for six months
and had planned on maxing out my $11,000 limit in January 2005 (under
my old job) with a portion of the severance. Can I then roll that
into an IRA after I leave the job and take it out as a down payment
on a house? Thanks. -- Allen
Your plan of action needs a little perspective.
If you'll be deferring money into your 401(k) only
to later withdraw it in the same year from an IRA, you haven't gained
much since you'll be taxed on the withdrawal.
While it's true that you can withdraw up to $10,000
in funds from an IRA to buy a first home (and tax law interprets
"first home" to mean that you haven't owned one in two
years), you have to pay income tax on the withdrawal. The only thing
you avoid is the 10 percent penalty on early withdrawals. So by
putting $10,000 into the 401(k) and later withdrawing it for the
home purchase, you're in the same position as if you did not make
the contribution to begin with.
For example, assume in January you get $100,000 in
severance and put $14,000 (the 2005 limit on 401(k) contributions)
into the 401(k), leaving you $86,000 in taxable income. Then you
transfer the 401(k) money into a rollover IRA. Later in 2005, if
you withdraw $10,000 from the IRA, your taxable income goes up to
$96,000, which is the same as if you only deferred $4,000 into the
My advice is to keep it simple and leave out the money
you need for the house.