On Sun, 1 Nov 2009, Jordan Hayes wrote:
> Example: your salary is $50k in 2008. You're single with no dependents
> and no interesting deductions. Your personal exemption was $3650, and
> your standard deduction was $5,700. Your taxable income was $40,650.
> Your tax was $6513 (plus $3825 FICA/Medicare) and your take home income
> was thus $39,653. Instead of listening to Joanna, say you elected to put
> in 10%, or $5k. Your taxable income drops to $35,650, your tax drops to
> $5263 (plus $3825 FICA/Medicare) and your take-home income drops only by
> $3750. Your $5k earns 3% in one year and is then worth $5150. You lose
> your job and withdraw all of it, paying a 10% penalty and no income tax
> because your income is below your exemptions. You're left with $4635
> which you "paid" $3750 for one year ago. This is a 23% return in one
> year, something that would make hedge fund managers drool.
This is a very well done example, except it seems to make one unjustifiable assumption:
> paying a 10% penalty and no income tax
> because your income is below your exemptions.
In most cases, you'll have annual income in the year you withdraw simply because you can't live without it (and they probably didn't fire you on January 1st). You'll probably be odd-jobbing in exactly the profession you used to have a steady job in and earning roughly the same income but without benefits and by working more hours. In which case you *will* pay income tax on that withdrawn money on top of the 10% penalty which will give you a return of less than zero. And if we're talking a larger amount -- if, for example, you really wanted to get your hands on the 50 grand you had saved now that you now desparately need -- it will be much worse and hurt like hell.
It doesn't invalidate your argument, but it makes it less of a no-brainer. It simply underlines what you say later on, that you shouldn't invest money long-term that you might need soon.
Michael