Q. We are both 50, and my wife is a teacher. We recently attended a workshop concerning buying back some retirement years. A sum of $20,000 would increase her monthly pension at age 65 from $2,500 to $3,500. We think this seems like a good plan since we don’t have all that much saved for retirement due to putting kids through college and general living expenses. We don’t have a lot of debt other than our mortgage, but we do have a problem coming up with the $20,000. We will be relocating soon to my new job in another state, and unfortunately our house is underwater, so that is not a source for this money. We will just rent it out until the housing market improves. It was asked at the workshop whether someone could use a spouse’s retirement funds to buy back the years, and the workshop leader said yes, if it was all right with the spouse. We didn’t have any idea this could be done and don’t understand how to go about it without taking a big tax hit. I have about $45,000 in my 401(k). Can I transfer part of my 401(k) to my wife’s retirement plan and avoid taxes since the money would technically still be in a qualified plan? We would like to get this issue resolved before we move, so an answer sooner rather than later would be appreciated.
I know you don’t have much money, but you should pay to meet with an adviser to review your personal situation. With that said, based on what you told me, it does sound like a good plan to buy back your wife’s years of retirement. $20,000 isn’t a lot of money for an extra $1,000 per month. Since you don’t have much in the way of retirement savings, I suggest you make sure and take the 100 percent joint survivor option even if it reduces the monthly benefit. Also, if you two haven’t been married most of your working lives, you may want to meet with a family law attorney, or at the very least document that some of your retirement money was used to increase your wife’s pension in the unlikely but possible event of divorce.
Back to your question. The workshop leader either misunderstood the question, you misunderstood the answer, or he gave out incorrect information. You can’t transfer your retirement funds to your spouse without tax consequences unless you die. You could borrow from your 401(k). If the plan allows, you are limited to borrow up to $50,000 or 50 percent of the vested balance of your account, whichever is less. I don’t usually advise borrowing from a 401(k), but in your case it may make sense. When you borrow from a 401(k), you are required to pay the money back, with interest, within five years. The good news is that you are paying the interest back to yourself. But if you don’t pay the money back within five years or before you terminate employment, you will owe income tax and a 10 percent early withdrawal penalty on any unpaid amounts. You also will end up replacing pre-tax money with after-tax money. If you are in the 28 percent tax bracket, it will take $1.28 in salary to replace every $1.00 you withdraw from your 401(k) plan.
Do not take a loan from your existing company plan. If you do, the loan will need to be repaid when you leave. If it is not repaid, you will owe income taxes in addition to a 10 percent early-withdrawal penalty since you are younger than 59-1/2. Contact your new employer and ask whether they will accept rollovers from previous employer plans or rollover IRAs, and if so, when you will be eligible to do so and take a loan. If they allow only rollovers from IRAs, you will need to take the additional step of rolling your current 401(k) to a rollover IRA and then transferring the IRA to the 401(k).
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 99466, Raleigh, NC 27624