401(k) Plans- Think Twice Before Cashing Out Your 401(K)
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The National Association of Securities Dealers (NASD) has issued an investor alert that provides good insight on whether or not it makes sense to cash out your 401(k) plan when changing jobs. As the NASD says if you’re thinking about cashing out of your 401(k), you may want to think twice or maybe three times before doing so. NASD is using the Alert to educate investors to the potentially devastating impact cashing even a modest amount of 401(k) assets can have on retirement savings. When you switch jobs before retirement, you usually can choose among several things to do with your 401(k):
- Leave the money in your former employer’s plan
- Roll over the money to your new employer’s plan if the plan accepts transfers
- Roll over the money into an Individual Retirement Account (IRA), or
- Take the cash value of your account
It may be tempting to choose the last option and use the money to buy a new television, take a cruise or even to pay off a debt. And you would not be alone in thinking that way: A recent study by Hewitt Associates indicates that 45% of employees cash out their 401(k) plans when they change jobs.
But the NASD Alert suggests that cashing out of a 401(k) before you are 59 ½ can cost you dearly, both immediately and in the long run:
- If you do not transfer your money to an IRA or your new employer’s plan within 60 days of receiving it, your current employer is required to withhold 20% of your account balance to prepay federal taxes.
- If you keep the money, you must pay federal income tax on your entire withdrawal. In addition, you may also owe state tax on your distribution.
- Plus, the IRS will consider your payout an early distribution, meaning you could owe a 10% early withdrawal penalty on top of combined federal, state, and local taxes.
When all is said and done, you could end up with a little more than half of your original 401(k) savings! In addition, you will owe tax annually on any future earnings your lump sum generates.
We encourage our readers to read the entire NASD Alert which can be found here. Also, for more information on 401(k) plans and other retirement planning strategies, please visit Soundview Financial’s Retirement Savings Guide.
