401k Rollover Tip: Don’t Ever Cash Out

February 19th, 2008  |  Published in 401K  |  3 Comments

When you leave a job, you will be confronted with a decision. If you had a 401k, you will have to decide whether you will keep it with the current plan administrator, roll it over into your new employer (if they offer a 401k), roll it over into a Traditional IRA, or cash it out. Each has its benefits and drawbacks but ultimately the worst of them all, in terms of long term sustainability, has to be the cash it out option.

If you cash out your 401k, not only are the taxes due immediately but you also take a 10% penalty. So, if you had $10,000 and are in the 25% tax bracket, you will only get $6,500 of your hard earned money. That’s right, of the $10,000 you rightfully earned, you will get only $6,500 of it!

But I’m in a tight financial situation! If you are in a tight financial situation, see if you can simply borrow from the 401k or qualify for a penalty free withdrawal. Borrowing is only allowed if your plan administrator allows it, please check with them for the specifics. Penalty free withdrawals are decided by the IRS and they cover situations where you become disabled, have significant medical expenses (expenses exceeding 7.5% of your AGI), have been ordered by the courts to pay up money, etc. You can find a list by doing a simple google search on 401k withdrawals.

Don’t accidentally cash out! If you decide to roll your 401k over into a Traditional IRA, you have two options. The first is a “trustee to trustee rollover” (or “direct rollover”) where the check is written directly to the new administrator. The second is where the check is made out to you and you have 30 days to deposit it into the new plan’s account. I always go with the first option. You never know what will happen and so you never want to tempt yourself with that kind of money. Life happens and you don’t want to have to deal with any issues that result.

Retirement is precious, don’t screw it up! The process is easy as long as you follow some simple rules, don’t screw it up by getting greedy and cashing out. Paying someone 10% to get your own money is ridiculous.

  

Responses

  1. Carnival of Personal Finance #141 - The College Years Edition — Broke Grad Student says:

    February 25th, 2008 at 8:04 am (#)

    […] retirehappy from My Retirement Blog explains why you shouldn’t cash out your 401k when you leave a job in 401k Rollover Tip: Don?t Ever Cash Out. […]

  2. Sumar Ahmed says:

    July 5th, 2008 at 1:11 pm (#)

    Very useful information, thanks.

    To clarify the issue on 401k withdrawals, you are allowed to withdraw from your 401k or borrow a loan from it if you’re facing “financial hardships.”

    The following are reasons acceptable by the IRS for a hardship withdrawal

    i) Repairs of primary residences
    ii) Funeral expenses
    iii) Payments necessary to prevent you from being forced out of your home
    iv) Home foreclosures
    v) Payments of college tuition & other educational costs such as room & board, transportation, food, etc.
    vi) Purchase of principal residence
    vii) Unexpected or un-reimbursed medical expenses

    401k hardship withdrawals are subject to a 10% early withdrawal penalty as well as income taxes due. For example if you withdraw $10,000 as hardship withdrawal, you will owe $1000 in penalty, as well as be taxed on the $9000. There are some hardship withdrawals however that are not subject to the 10% penalty, they are:
    Source: http://www.401klookup.com

    i) You stop working, get laid off, quit or retire in the year you turn 55 or after
    ii) Court orders you to give money to a divorced spouse or dependent
    iii) Unexpected medical debts that exceed 7.5% of your Adjusted Gross Income
    iv) Permanent disabilities
    v) You stop working and begin taking regular payments based on a schedule that will make equal payments for the rest of your expected life; this must last for 5 years or until you turn 59 and 1/2, whichever is longer.

  3. MikeKlenner says:

    June 29th, 2010 at 5:18 am (#)

    401k rollover plan allows the employees for a well balanced retirement plan. There are many options for the traditional individual retirement account and the 401k rollover plan is good method for happy retirement.