A family member has recently been ordered to pay child support to her former spouse for the next 18 months. Because she does not believe her monthly budget will allow for the amount required, she wants to derive the funds from her existing assets. She needs about $9,000 to cover the entirety of the payments. She holds at least this amount in three different forms: 1) a savings account, 2) a 401(k) through her employer, and 3) stock in her employer’s company. Which of these three options is the smartest move financially?
FPA member Scott K. Alexander, CFP®, a financial planner with Sea Island Bank/Synovus said a definitive answer may not be possible without more information. However, here are some thoughts that may help.
“First of all, taking a distribution from her 401(k) would likely be your family member's worst choice, assuming in-service withdrawals are even permitted,” he said. “Assuming the contributions were made with pre-tax dollars, the distribution will be taxable income to her, plus she'll probably pay penalty taxes depending on her age, unless she can qualify for a hardship distribution. If her employer's plan has a loan provision, however, she could borrow up to the lesser of 50 percent of the balance or $50,000, which she would have to repay with interest on a schedule over the next five years. Since the interest is going into her account, this might be less costly in the long run than a bank loan. Plus, a five-year schedule should be easier on her cash flow than the 18-month version.“
“You didn't mention your family member's cost basis in her company stock, or its merits as an investment, and whether it's publicly traded,” he said. “Obviously, if it's a seriously overbought publicly traded stock, she may want to sell it — regardless of whether she uses the proceeds for the child support payments. If the stock is cheap right now, she may want to keep it.”
“You didn't mention whether your family member owns a house,” he said. “If she does, she may be able to set up a home equity line of credit, against which she can draw funds as needed for the child support payments. The interest would be tax deductible (under current law), and repayment terms could be flexible. She may want to set up the line of credit anyway, just to have it as a backup resource for emergency cash.”
“Using her savings account may be her best option,” said Alexander. “First, it doesn't preclude the other options: your family member can borrow versus her 401(k) or sell company stock later and refund her savings account. Second, it's probably not earning much interest right now anyway.”