Cashing Out a 401k Can Be Expensive
With the recent economic downturn, Americans have become increasingly concerned about job security-and with just cause, cashing out a 401k plans to help to meet those needs. Unemployment remains at right around a 10% rate, not even counting those who aren’t fully employed, and that means many people will search for additional funds to help them get through this financially uncertain period of time. As a result of these difficulties, some may choose to look at cashing out a 401k early.
Just a few things to think about cashing out a 401k , as this seems like a great short term fix, but this transaction carries a steep price. For example, if you have $25,000 in your 401k and decide to take a lump-sum distribution after leaving your job, you'll lose the benefits of the tax deferred growth, and the opportunity for investment returns worth thousands of dollars.
Example of cashing out a 401k
In this example, assuming an eight percent annual return, that same $25,000 could reach nearly $116,523.93 in just 20 years. Additionally, taking a distribution can mean you'll incur a 10 percent early-withdrawal penalty as well as federal and state income taxes. If you're in the 27.5% tax bracket, a combination of federal taxes and penalties will add up to a large bite-$9,375 before state taxes-of your $25,000 distribution. 
To avoid such losses, instead of taking a lump sum, consider rolling your 401k to an IRA, AKA an Individual Retirement Account. By making this move, it will not only give you an increased number of investment options, but also will provide you with more control over your money. With an IRA, you can invest your savings in a number of different ways, including stocks, bonds, mutual funds, real estate, precious metals, and certificates of deposit. Just like a 401k, your assets will still grow on a tax-deferred basis, which means that they will compound without having to pay capital gains taxes.
So much focus is always put on the saving portion of retirement that the distribution phase is ignored entirely. Keep in mind that IRAs provide many additional options for distributions than a traditional employer plan. In addition, another benefit is that you can convert to a Roth IRA, and in 2010 you can do so at any tax bracket. You'll pay taxes on the conversion amount (in 2010 you can defer this penalty over a number of years), but you'll be able to enjoy the benefits a Roth IRA, including the tax-free growth, and most importantly, no taxes on withdrawals.
- So, when you leave your job, you have several options for the money in your 401k, including:
- take it and spend it;
- keep it in your former employer's plan;
- transfer it to your new employer's plan;
- or roll it over into an IRA.
Before making this critical decision, consider the impact of your actions. Generally speaking, Americans who took a lump-sum distribution from their retirement plan, more than half chose not to roll the funds into any type of IRA. Especially considering the recent rise in layoffs, millions of Americans may be seriously jeapordizing their future retirement assets when they get the axe.
If you'd like to learn more about rolling the money from your 401k into a type of IRA, and how to structure your retirement fund dollars, consider consulting a financial advisor. A good financial advisor can answer any questions you may have about a rollover IRA thereby helping you to make the most of your retirement funds by putting together a financial plan that's in step with both your current and future needs.
You can find a qualified financial advisor in eRollover's database by clicking here.
