Cashing Out 401k
When facing financial strife, cashing out 401k is a very tempting solution. It is after all savings you have put away from all the years of working hard. It seems justifiable and a very ready solution but it is not advisable for a number of reasons.
For one, you will lose the three main benefits of this fund. One is that it is a way to bring down taxable income as the contribution is deducted before taxes are levied. Most of the plans involve a matching contribution from the employer and this will be lost. Thirdly, the money saved in this fund enjoy tax deferred growth which gives better compounding that if the amount were to be taxed every year. As of 2010, the federal limit on a yearly pretax 401k fund was upped from a maximum of 16,500 US dollars to 22,000 for people aged 50 years and older.
One reason is that it may cost quite a bit to cash out your 401k and more in future. Even if the amounts you have been invested are not big amounts, they keep growing to a significant amount over time. Factor in the tax-deferred compounding and the amount keeps growing.
It may be that you are leaving a job and you are unsure how to handle a 401k fund that an employer has been sponsoring. There are four options here. One is that to leave the fund alone and let it keep growing with the former sponsor and the second is to roll it over to the new employer if you are leaving to go a new job.
You can also roll it over to what is known as an Individual Retirement Account (IRA). The last and one you should avoid is to cash out the fund and pay the taxes and penalties that come with doing so. If you do opt to cash out, it would be advisable to do so to the IRA account. The best way to do this is through a direct transfer from the current plan trustee to the IRA custodian. Some IRA rollover companies do this at no cost and they do not have minimum balance requirements, any maintenance fees or custodial fees.
The other reason that a 401k cash out is not advisable is all the taxes and penalties you have to pay. If the withdrawal process does not adhere to the rules stipulated by the Internal Revenue Services (IRA) it is classed as a non-qualified distribution. This costs as much as 30 to 40 percent in taxes and 10 percent in penalty fees.
In addition, there will be a loss of retirement funds in the range of 5 to 10 times in amount. The state and federal tax authorities will levy fee of 10 percent as early distribution penalty if you are less than 55 years old at the time you leave your job.
To avoid these kinds of taxes and penalties, a better option is borrowing from your 401k fund. There are plans that allow employees to do this with the borrowed amount being repaid with funds that will be taxes at set interest rates. The proceeds from interest become part of the fund balance. The loan is neither subject to tax like taxable income is nor the 10 percent penalty as long as it is paid back as stipulated by the IRA code. If the loan is defaulted on, it becomes taxable and subject to the same tax penalties as a withdrawal.
Alternatively, consider options like applying for a home equity loan or refinancing to get the means to cover expenses if the circumstances are that you have lost your job rather than left to go into another or start a business. There is also reprieve in the form of consolidation loans to cover debts. Lenders are also in most cases willing to negotiate the terms of a loan rather than repossess property, cars or other items rather than be stuck with the item in the current gloomy economic climate.
If you decide to go ahead with cashing out 401k, notify your employer and ask about their withdrawal process and requirements. Decide the percentage of the fund you wish to cash out. You can roll over the balance to an IRA account. Send the paperwork to your 401k administrator or relevant department. What is often done is that the administrator will subtract 10 percent of as distribution penalty before the payment. The state and federal taxes are left to you to handle. Verify that when the check comes, the amount on it is accurate. If it has come down to cashing out 401k, put the funds to good use.