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.