If you switch jobs and have a 401(k) through your previous company, you may have the option of cashing it out.
Many employees choose to take the money instead of keeping it marked for retirement. Among investors, one out of three has cashed out a 401(k) before age 59 1/2, according to data from Fidelity Investments.
However, before taking money out of the account, it pays to evaluate your reasons for the withdrawal, as well as the financial consequences that could result from the distribution. Here are some factors to consider before cashing out a 401(k).
[See: How to Max Out Your 401(k) in 2018.]
Calculate what you will pocket. The amount you have set aside for retirement will drop significantly if you cash out. If you are under age 59 1/2, your withdrawal will generally be subject to a 10 percent penalty fee. If you are older than 55, you might be able to avoid the 10 percent penalty if you separated from service to your employer after age 55. This exception will only be available if your plan allows distributions before normal retirement age.
The amount you take out will also be subject to income taxes. “It is not uncommon for 50 percent or more of the funds to get vaporized with taxes and penalties,” says Blake Christian, a partner at HCVT in Long Beach, California. Depending on your tax rate, if you have $10,000 that you want to cash out, you could end up with as little as $5,000 after taxes and fees.
Consider if the funds are necessary. Ask yourself if the money is needed to help cover unexpected costs, and if so, evaluate the cause. “A financial emergency is a situation that, if not dealt with properly, can adversely affect your ability to live in your home, your health or your ability to pay for essential items,” says Spencer Pringle, executive vice president of retirement solutions at Retirement Clearinghouse in Charlotte, North Carolina. Essential items might include basics such as food, daily transportation, utilities or paying off a defaulted loan.
[See: 9 Ways to Avoid 401(k) Fees and Penalties.]
Look into other ways to access cash. If you’re going through a tough financial situation, calculate the exact amount you’ll need to cover expenses. “Even in a financial emergency, you may only require a portion of your 401(k) balance,” Pringle says. “In most situations, you can cash out the amount you need to handle the emergency and keep the remaining amount invested.”
Also look at other options for gathering the funds you need. You might be able to tap an emergency fund, take out a loan, refinance your mortgage or cut other monthly expenses to help cover the costs.
Think about continuing to invest. Instead of cashing out the 401(k), you may be able to leave it at your previous workplace. “By leaving the funds with the former employer, the 401(k) fees are generally low and investment choices are often broad,” Christian says.
If you don’t leave the funds with your last company, there are other ways to keep the money set aside. “You can roll your existing plan into your new employer’s plan if your new employer’s plan permits such rollover contributions,” says Steven J. Weil, president of RMS Accounting in Fort Lauderdale, Florida. Another option involves putting the money into a rollover IRA. Rolling the funds into this type of account allows the money to grow on a tax-deferred basis. You will also be able to access the funds at a later point if you need them.
Go through long-term projections. Money you have set aside for retirement can continue to grow during the coming decades. If you take it out now, you’ll lose out on potential interest and earnings that would otherwise accumulate over time. “The costliest part of cashing out is that you miss out on the future growth of the money you withdraw,” says Jason Cabler, founder of the Celebrating Financial Freedom blog. Say you have $20,000 set aside. If you cash it out, you’ll forfeit a significant amount of future earnings. Keeping $20,000 in an account with a 10 percent return for 20 years could amount to $150,000.
Another factor to keep in mind involves your goals for retirement. If you plan to maintain your current lifestyle, you’ll want to make sure you have enough saved to carry out your retirement goals. Cashing out now could bring immediate, but not long-term, benefits.
[Read: New 401(k) and IRA Rules for 2018.]
Talk to an advisor. Making a decision that is right for your financial situation is not always a straightforward process. Say you are trying to pay off lingering debt and are wondering if cashing out a 401(k) is a smart move to reduce balances. Or you might want to start a business, in which case a rollover for business startups might be an option. This type of account allows you to move funds from your retirement plan into your business without paying taxes or penalties on the amount.
If you’re trying to gather funds to make a big purchase, such as a home renovation, it may be best to try to boost income in other areas, such as taking on a side gig. “This is a complex area with many choices and possibilities,” Weil says. Sit down with a financial or tax advisor to go over your available choices, and use the input to make a decision that meets your current and long-term needs.
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6 Factors to Consider Before Cashing Out a 401(k) originally appeared on usnews.com
