Are you considering a cash distribution instead of a 401k rollover? Well, I am going to be brutally honest in saying unless you are absolutely desperate for money or over the age of 59 1/2, you would be crazy to cash out and should go with a rollover 401k instead! I do realize that a cash distribution is the most tempting option available for you to take but it can also be the most costly.
If you leave a company and decide to physically receive a part of or all of your 401k assets, this is considered a cash distribution. You may think, “This is my money so I will take it and run”, and the truth is, yes, you can take the money and run but not without paying some hefty taxes first. State and federal income taxes will take a portion out of your distribution. When you made the contributions to your 401k you probably did so with pre-taxed dollars. Your employer contributions were also tax deferred. When you go with a cash distribution you pay income tax on all pre-taxed earnings. Then there is a mandatory withholding of taxes of 20%. Yep, you read that right, 20%. So if you had $50,000 in your retirement account and you cashed out your distributions you would pay $10,000 in taxes that your previous employer must pay to the IRS. If you are still considering this, you also may have to pay a 10% penalty called a premature distribution for withdrawing from the account if you are under the age of 59 1/2 at the time you decided to leave the company. Essentially if you had $50,000 you would have to pay $5,000 for penalties. So if you add all the taxes you will pay your $50,000 is now $35,000 or less all because you cashed out early.
Unfortunately, the only benefit to this option is that you have hard cash in your hands now, rather than later. So if you are in a financial crisis, and by crisis I mean serious medical injuries or tying to save your home, not buy a new wardrobe, then this would be a good option for you to take if you are willing to take the big financial hit. We all know the tax man is going to get any money he can from us but this is also to deter you from withdrawing early. The point of a retirement savings account is so that it can continue to grow and earn you money so you can one day retire. If you withdraw early you have now taken a big chunk of that money and thrown it away. Please think about your options and look into the 401k rollover options available whether it’s a 401k rollover to IRA or 401k rollover into your new employer’s retirement plan. A cash distribution option is not something to take lightly. The money in hand seems nice but you will miss it greatly when you are retired! You may need to seek the advice of a tax adviser if you are still unsure about taking a cash out or if you need a third party to help you decide whether this is your best financial option.
- Cash Distributions are only a good idea if you are in a financial crisis and need the money. Speak with a tax advisor or 401k professional to determine if this is your best option.
- You will get dinged quite a bit by the tax man for cashing out early
- If you are unsure of what to do with your money, leave it in your current 401k plan until you have done some research or consulted with a professional regarding your next move