If you lose your job and have a 401(k) through your previous company, you may have the option of cashing it out. Sometimes employees choose to take the money instead of keeping it in a retirement account. However, before accessing the money, it pays to evaluate your reasons for the withdrawal and the financial consequences that could result from the distribution.
Here are some factors to consider before cashing out a 401(k):
— Calculate what you will pocket.
— Consider if the funds are necessary.
— Look into other ways to access cash.
— Think about continuing to invest.
— Consider the benefits and consequences.
— Talk to an advisor.
Calculate What You Will Pocket
The amount you have set aside for retirement will drop significantly if you cash out. The withdrawal will be considered part of your taxable income. You’ll also have to pay a penalty of 10% if you are younger than 59½. These charges will reduce what you’re able to keep.
The IRS waives the penalty for certain hardships, including becoming disabled and approved disaster relief. Some plans allow for hardship withdrawals. Talk to the plan’s administrator or the human resources department to learn the full details of your plan.
[READ: How Much Money to Have Saved for Retirement by Age 40]
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, senior vice president for operations at Retirement Clearinghouse in Charlotte, North Carolina. Essential items might include basics such as food, daily transportation, utilities or paying off a defaulted loan.
Look Into Other Ways to Access Cash
If you’re going through a tough situation, calculate the exact amount you 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 to gather the funds. You might be able to refinance your mortgage or take out a loan. “Most people are unaware that some plans give them the ability to borrow money instead of claiming a hardship and surrendering the amount,” says Ron Tallou, retirement expert and investment advisor at RJP Estate Planning in Scottsdale, Arizona. Check with the plan administrator to see what is allowed through your 401(k) and what the repayment terms would be for a loan. “By borrowing it, you avoid the penalties and can put it all back,” Tallou says.
[Read: Should You Use Your 401(k) to Pay Off Debt?]
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,” says Blake Christian, a partner at HCVT in Long Beach, California, and Park City, Utah.
If you don’t leave the funds with your former company, there are other ways to keep the money set aside for retirement. “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.
Consider the Benefits and Consequences
Cashing out a 401(k) will enable you to have the funds right away. If you lose your job and use the money to cover living expenses until you start a new position, an early 401(k) withdrawal might help you avoid going into debt. Once your income increases again, you can get back to saving for retirement.
However, the long-term consequences of cashing out can be steep. If you cash out your 401(k) now, you’ll lose out on potential interest and earnings that would otherwise accumulate over time. Perhaps you have $20,000 set aside. If you cash it out, you’ll forfeit a significant amount of future earnings. Keeping $20,000 in a retirement account with a 10% return compounded annually for 20 years could amount to more than $130,000.
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. Leaving money in the account, rather than taking it out, could help you reach those financial goals.
[READ: 9 Ways to Avoid 401(k) Fees and Penalties]
Talk to an Advisor
Making a decision that is right for your financial situation is not always a straightforward process. You need to compare the urgency of your immediate needs to your ability to achieve your long-term goals. In some cases, you may be able to boost income in other areas, such as taking on a side gig. You might also be able to cut expenses or make arrangements so you can pay off bills over a longer period.
“This is a complex area with many choices and possibilities,” Weil says. Sit down with a financial advisor or tax advisor to go over your choices and use the input to make a decision that meets your current and long-term needs.
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Factors to Consider Before Cashing Out a 401(k) originally appeared on usnews.com
Update 08/02/23: This story was published at an earlier date and has been updated with new information.
