Q. My 55-year-old son-in-law hasn't worked long enough to qualify for Social Security. He has a 401(k) plan and says he's been advised to turn it into cash when he retires and use the money to buy into Social Security. Is that really possible?
A. Sorry to say, but the advice is wrong: You cannot "buy into" Social Security. To be eligible for retirement benefits, you need 40 Social Security credits, which you earn by working at a job covered by the system or having net income from self-employment. In 2012, you receive one credit for each $1,130 of earnings, up to a maximum of four credits per year. Thus it generally takes 10 years of work to earn the necessary 40 credits.
See also: Will getting a pension lower my benefit?
Meanwhile, there's another problem with the advice given to your son-in-law. It sounds like he wasn't told about the tax implications of cashing out a 401(k).
Money in those accounts is deposited before income taxes are deducted; you pay taxes on the money when it comes out. So when workers retire, they often roll over their 401(k) money into tax-deferred mutual funds or other such investments to put off the day when taxes are due.
But if your son-in-law were to take his 401(k) money in cash, his employer would be required to withhold 20 percent for income taxes, which would be sent to the IRS as a down payment against income taxes due on the money. (And this assumes that he's at least 59 1/2. If he's younger, there would probably also be a 10 percent penalty for an early withdrawal.)
For instance, if your son-in-law took $100,000 from his account, his employer would send $20,000 to the IRS. Your son-in-law would receive a check for only $80,000. All of the $100,000 would be taxable, unless he opened an IRA rollover account somewhere within 60 days. And if he did, he'd have to deposit the full $100,000, meaning $20,000 would have to come out of his own pocket. The $20,000 sent to the IRS could be recovered when he files future tax returns.
The conclusion: Much hassle for little gain.
You may also like: 10 ways to tune up Social Security.
Stan Hinden, a former columnist for the Washington Post, wrote How to Retire Happy: The 12 Most Important Decisions You Must Make Before You Retire. Have a question for the Social Security Mailbox? Check out the archive. If you don't find your answer there, send a query.
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