Although cashing out 401k can be a very tempting financial assistance option because you are simply taking the money you have saved from the years of your hard work, you should think twice before you go for it.
While this opportunity may appear to be a good deal at the outset, it may cost you a lot of money today, and more money down the road. Even small amounts you have invested today can eventually grow into a large sum with enough time and tax-deferred compounding.
If you are planning to leave your job and don’t know what to do with your employer-sponsored retirement plan, you have 4 options to choose from:
- Just let it grow with your former 401k plan provider.
- Roll it over to your new employer’s 401k plan.
- Roll it over to an Individual Retirement Account (IRA)
- Cash out the 401k balance and just pay the penalties and taxes.
Use our Cash Out Calculator below to find out how much cashing out will cost you:
Cost of Cashing Out 401k
This calculator assumes a tax rate of 30% and IRS penalties of 10%. Distributions received before the age of 59.5 are subject to an early distribution penalty of 10% additional tax unless an exception applies.
Most financial advisers will inform you that the best option is to rollover your account instead of getting the money and paying for the penalty for cashing out 401k. While it is understandable that every person’s situation is unique, a cash out is not always the best step to take. It’s most beneficial to consult a financial expert before deciding on this matter.
Don’t Cash Out – Rollover Your 401k!
The best method of cashing out your 401k would be to roll it over into an IRA. After you have your IRA account setup, the simplest way for you to roll over to an IRA is to arrange a direct transfer of your 401k account value from your plan trustee to the custodian of your IRA.
The best IRA rollover company we’ve found is Scottrade. They have an all-in-one IRA with no minimum balances or maintenance fees and make it super easy for you to rollover your 401k into an IRA.
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All you have to do is just provide your IRA account number to the person who handles retirement matters for your employer, and authorizing the move. If you’d prefer handling the transfer yourself, you can also request a check from your employer, but beware that certain restrictions apply in doing so. It’s best to contact your IRA provider to discuss any specific requirements and details that are required to rollover your IRA.
Setbacks of Unqualified 401k Distribution
During difficult times, it may be enticing to cash out the 401k money. However, this opportunity may be more costly than even utilizing credit cards to get by your current financial hardships. It is highly recommended to only perform a 401k hardship withdrawal as your last resort.
In fact, a 401k withdrawal that is not made within the rules stipulated by Internal Revenue Service and considered as a non-qualified distribution will cost you 30 to 40 percent of tax and another 10 percent penalty fee. Let alone, you will have to deal with 5 to 10 times the amount in lost retirement funds from cashing out!
You will also recompense state and federal tax and another 10% early distribution penalty if you are less than 55 years of age when you leave your job. Use our Cash Out Calculator to find out exactly how much cashing out will cost you!
If you are 40 years of age and have $50,000 in your 401k account, cashing out your 401k will incur you 27% federal tax bracket amounting to $13,500 in taxes, or even higher. Then, another 10% penalty amounting to $5,000 will be deducted in your account. You’ll end up with just 60% of your account balance. Furthermore, the state income tax will most likely cost you another $2,000 up to $3,000.
In essence, when you cash out your 401k funds, you restart the clock of saving and investing for your retirement. As a result, you will fail to take advantage of the growth on your retirement money that you have withdrawn.
Alternative Financial Assistance Options
Similar to the reasons given when a participant makes an IRA hardship withdrawal, being laid off from work may force you to cash out 401k to cover your expenses. Oftentimes, it may be more helpful borrowing from 401k, instead of getting all your account funds. Maybe a home-equity loan or refinance to get by until you recuperate instead of getting your money from your retirement account is a better option.
If you are far behind your mortgage payments, you’ll be delighted to know that there are many firms out there ready to help and renegotiate your loan and debt terms with your lender or bank.
Steps in Cashing Out
If you are already decided that you’ll get the money out of your 401k account, here is the straightforward process that you should follow to cash out the right way:
- Have a meeting with the HR department of your company providing your 401k. Note that every company has specific process for taking the money from this account.
- Decide on the percentage of the 401k account balance that you plan to cash out. You have the opportunity to only procure part of the account and then rollover the rest of the money in another retirement account.
- Our cash out calculator can help you determine the expenses associated with the cash out. It would also be a good idea to send the paperwork to your 401k administrator or the assigned department. Note that the administrator often subtracts ten percent distribution penalty before the payment, while the state and federal taxes are your sole responsibility.
- When you receive the check, make certain that the amount is accurate. Remember, cashing out 401k is not always the best option, but if you really need the money make sure you put it into good use.