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By HELEN HUNTLEY
© St. Petersburg Times, published April 23, 2000
Q. I was awarded a settlement of $1,100 a month for life tax-free. The problem is that I owe $40,000 on high-interest credit cards and a home equity loan in addition to my mortgage. I have been offered $100,000, less $10,000 in attorney's fees, as a lump sum for my settlement. I figure I could pay what I owe and invest the remaining $50,000. I am 62 and collect Social Security disability while my wife is 57 and cannot yet collect Social Security.
I have been advised to put about $38,000 of this settlement into equity annuities and $10,000 in a money market account, which would leave us $2,000 in the bank. We are new to investing. What would you suggest?
A. I see a lot of problems with your plan. First of all, I think you probably would be better off with the monthly income than the lump-sum settlement, particularly because you have no investment experience. Second, someone in your low tax bracket should not invest in an annuity. You would be better off with taxable investments.
Clearwater financial planner Ray Ferrara calculates that your settlement payments will be worth more than $100,000 if you collect for more than 10.75 years, assuming a discount rate of 7 percent. He suggests you take into account your health and whether there are any provisions for continuation of payments to your beneficiary after your death. He also notes that your settlement payments may be protected from creditors, an advantage for someone with debt problems.
"Given his tax status, the equity annuity does not seem to make sense," Ferrara said. "If he puts the money into the annuity and needs cash flow, it will be taxed at 15 percent if he is in the lowest tax bracket. If he invests the money into a mutual fund then he would be taxed at a 10 percent capital gains rate. If his income is such that he is not taxed at all, then the lower costs associated with a mutual fund versus an annuity would still justify the mutual fund."
Before you reach a decision, I suggest that you discuss your financial situation with a counselor at one of the consumer credit counseling agencies. For a referral to a location near you, call (800) 388-2227.
You may be able to develop a debt repayment plan. If your wife is not already working, she could get a job and put your debt repayment on a fast track. While you might consider her working to be a sacrifice, it would be less of a sacrifice than giving up $1,100 per month in lifetime tax-free income.
If you are not able to work out a debt repayment plan, bankruptcy might be an appropriate alternative, particularly if most of your debt is in credit cards rather than in the home equity loan.
Good luck!
Q. What are the rules regarding 401(k) withdrawals for hardship reasons? My employer is giving me the runaround.
A. You probably are out of luck. A 401(k) plan is not required to offer hardship withdrawals. If it does, your hardship must meet the Internal Revenue Service definition of "an immediate and heavy financial need." According to the IRS, that includes uninsured medical expenses, tuition payments and purchase of a home, but not mortgage payments on a home you already own except to stave off foreclosure. Your plan documents may list other qualifying hardships, such as funeral expenses. It sounds as though your employer does not think you have a qualifying hardship.
When withdrawals are permitted, you cannot withdraw more than the amount needed for the qualifying hardship and you cannot withdraw more than your actual contributions, not including investment earnings.
If your 401(k) plans permits borrowing, that would be a better alternative.
If you like reading stock market commentary, check out(StocksandNews.com), put together by Brian Trumbore, a former executive vice president at PIMCO mutual funds. In addition to his weekly take on the news, he offers history lessons and commentary on foreign affairs.
-- Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, send it to On Money. We'll try to answer those we think are of greatest reader interest. All questions must be submitted in writing, but readers' names will not be published. Send questions to Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731, or to huntley@sptimes.com by e-mail.