||Ask Dr. Don
Divorce settlement proceeds
Dear Dr. Don,
I just got a divorce, and will be receiving about $300,000 from
a retirement fund. I will have to roll over that money to avoid
taxes, but I was wondering if it would make sense to pay off my
mortgage; which has a 6.85 percent variable rate, and a balance
of $82,000. I am barely making ends meet, and paying that off would
free up $800 a month. Or, should I just roll it over?
Without knowing your age, your overall financial situation or your
financial goals it's difficult to provide advice. Instead, I'll
give you a few things to think about while you look for a fee-based
financial planner, a tax professional, or both to assist you. The
Association of Personal Financial Advisors can help you find
a fee-only planner in your area.
Cashing out enough to pay off the mortgage is worth
considering. You may even be able to avoid the 10 percent penalty
tax if the retirement proceeds are received as a lump sum under
Domestic Relations Order.
Even if you don't have to pay the penalty tax, you
will still owe income taxes on the amount received as a lump sum.
The balance of the $300,000 can be rolled into your retirement account
tax-deferred. The table below shows that you'll need to withdraw
a lot more than your loan balance after considering taxes and the
early distribution penalty, if applicable.
Marginal Federal income tax rate
|Penalty on early distribution
|Funds needed if subject to penalty tax
|Funds needed with no penalty
The appreciation in your home's value over the years
should be mostly tax-free with the current capital gains provisions
on the sale of your home. So you're paying taxes upfront on the
distribution from the retirement account, but the money can grow
tax-free, at least up to the limits of the capital gains provision.
You'll lose the mortgage interest deduction on your taxes, but save
the after-tax interest expense on the loan balance while freeing
up $800 a month.
If you go this route, don't let your spending on discretionary
items use up all of the $800 that you've freed up in your monthly
budget. Start a savings and investment plan to help you meet your
future financial goals.
-- Posted: July 16, 2002