Keep Your Money Working Even When You're Not

By Martha M. Hamilton
Sunday, May 27, 2007

This is the kind of subject that requires knocking on wood at the same time you're tapping on the keyboard.

It's about unemployment and trying to avoid taking money out of your retirement savings accounts when you're between paychecks.

What got me thinking about this particular dilemma was a recent speaking engagement. I was scheduled to talk to a group called 40 Plus of Greater Washington, which provides job-hunting help and networking opportunities to job-seekers 40 and older -- the kind of folks who are likely to have built up decent savings and who may be tempted if they're strapped for cash. What would I do in their place?

I knew I'd try to keep my hands off. But what's the best way to do that? I asked two financial experts, Ed Slott, an IRA expert and author of "Your Complete Retirement Planning Road Map," and Barry Glassman, a financial adviser with Cassaday & Co.

And what I learned was helpful -- even if you're not unemployed. So don't stop reading.

I've been strapped for cash myself. I struggled financially for several years after my divorce, making the painful transition from two salaries to one and trying to hang on to a house I loved.

In the process, I learned how to cut costs, where to find money and how not to turn up my nose at even small savings. I took fashion mistakes to the consignment shop. I decluttered my house through garage sales. I got rid of cable TV, which I seldom watched anyway. And I learned to operate a chain saw (lots of trees in my yard). I also took a basic plumbing course from Washington Water and Sewer Authority and learned how to change a light switch instead of paying someone else to do it. (Best lesson from WASA: When you take something apart, make a grid on a piece of paper or cardboard, and lay the pieces on it in the order you remove them. Then you won't have to guess the order in which to put them back.)

I also looked at services I had renewed year after year without thought -- like insurance -- to see whether I was paying too much. Turned out I was paying about 80 times the going rate for long distance when I finally ditched my longtime AT&T service. While I had been distracted by a long series of personal crises, a telecommunications revolution had occurred.

There were days when I had to count the change in a small tin bank on the dresser before I could say yes to a movie. But at least I was still working, so I didn't have to think about draining my retirement accounts.

But what if you're unemployed, and you've cut back as much as you can? And yet, those bills keep coming.

Well, first of all, avenues for getting cash available to you when you're working go away when you're not. Typically, you may no longer borrow against your 401(k) once you've left the job (paying interest back to your own account), and if you already have a loan, you have to repay it quickly or pay a 10 percent penalty plus taxes on the amount withdrawn.

Also, if you don't have a home equity line of credit, you can't get one. As Slott said, it's the old truism: Banks like to lend you money when you can prove you don't need it. If you do have a home equity line of credit, that might be one of the better places to go for interim funds. Sure, you'll have monthly payments to make, but at least the interest you're paying is tax deductible, and the rates are usually not as high as credit card loans.

But how about withdrawals from your retirement accounts? If you have a Roth IRA, you're eligible to withdraw all the money you've contributed to the Roth (but not the money earned on those contributions) without penalties, even if you're younger than 59 1/2 -- the age at which you're normally free from penalties on withdrawals from retirement savings accounts. That might be attractive, but it means that money won't be working for you anymore.

If you don't have a Roth IRA, that leaves either your 401(k) plan or your traditional IRA. If you have a 401(k), don't cash it out. If you're under 55, you'll pay both a 10 percent penalty and 20 percent at the time of withdrawal in taxes, and -- if you've been working for most of the year, it could kick you into a higher tax bracket. You don't need that right now.

If you have company stock in your 401(k), you may want to roll over everything but the stock into an IRA so you don't have to deal with your former employer's 401(k) restrictions. When it comes to the stock, you want to transfer it into a taxable account, such as a brokerage account, to take advantage of a relatively little-used provision of federal tax law called "net unrealized appreciation." This applies whether you're unemployed, changing jobs or retiring.

Here's the deal. If you paid $100,000 to acquire stock now worth $500,000, you pay taxes only on the $100,000 you spent on the stock, not on its current value. And once the stock is in the taxable account, you can sell it as needed and only incur a capital gains tax of 15 percent, or possibly even less, depending on your income.

If it comes down to borrowing from a retirement account versus borrowing on credit cards, this may be one of the rare times when it makes sense to borrow on credit cards. Sure, the interest is high, but if you're younger than 55, you'll pay penalties to withdraw from the 401(k), and if you're younger than 59 1/2 , you'll pay penalties to withdraw from your IRA -- plus taxes. And once it's gone, you've permanently lost the ability of the money to work for you -- even while you're not working.

Any questions about retirement that you'd like to see explored in the column? Please e-mail me

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