Thinking of cashing out your 401(k)? Learn about the implications and get informed about the alternative choices like a roll over to an IRA before withdrawing your 401(k).
Understand the potentially significant impact of fees, taxes and penalties that result in cashing out your 401(k)
By cashing out your 401(k), you can’t make up for the power of earnings lost over time
Switching jobs can have its perks—new opportunities often mean new experiences, an expanding skill set, and perhaps an enticing salary and benefits package. And with the benefits of a new job comes a very important question: What to do with your old 401(k)?
If you’ve contributed to a former employer’s 401(k), it may sound appealing to use your assets to pay off debt or fund an upcoming purchase like a down payment on a car or home. However, the long-term impact of cashing out your 401(k) can be quite significant.
Fees, taxes, and penalties can considerably reduce the amount of money you’ll receive from cashing out your 401(k). The amount you cash out will be subject to a mandatory 20% withholding for federal income tax, and there is an additional 10% early withdrawal penalty if you’re under age 59 ½. You may also be responsible for ordinary income tax on the full amount of your distribution as well as state and local taxes, depending on where you live.
More importantly, a benefit of a tax-advantaged 401(k) account is that it allows your pretax contributions to continue growing tax-deferred. Over time, your earnings can generate their own earnings, potentially helping you accumulate even more. Alternatively, if you cash out your 401(k), you can’t make up for the power of earnings lost over time.
But there are alternatives to cashing out that can help keep your retirement plan going, and potentially growing, over time.
Determining what to do with your old 401(k) is an important financial decision you may need to make many times in your career. And you’ll want to carefully consider all of your choices, including not just cashing out but also the ones that may help your account continue to grow. These choices are: leave it with your former employer, roll it into your current employer’s plan, or roll it over to an Individual Retirement Account (IRA). Please visit tdameritrade.com/rollover for more information on rollover alternatives.
When considering the choices available to you, it’s important to understand the impact each choice has on your investment. Questions to ask yourself as you go through this process might include:
After asking these initial questions, refer to the information below and visit the TD Ameritrade Rollover IRA page for a more complete list of the advantages and disadvantages regarding each choice.
Some employers will let you keep your 401(k) where it is when you leave, and this may be a solid alternative to cashing out. Your old plan might offer low-fee products, and despite any administrative fees you may be assessed, your old plan may still be your lowest-fee alternative.
Though your funds can continue to grow tax-deferred, you won’t be able to contribute additional funds going forward, and you’ll be limited to the investment choices the plan offers. Plus, as a former employee, you may be subject to certain administrative or record-keeping fees (you should check with your former employer).
This involves taking your old 401(k) plan and “rolling it over” either into your new employer’s plan (if your new employer allows that) or into an IRA. In both cases, you’ll be able to continue making contributions and your funds can grow tax-deferred, but after that, these choices differ.
Rolling your 401(k) into a new employer’s plan lets you consolidate your old and new 401(k) savings in one place. Your investment choices will be limited to only those offered in the new plan, but, again, your new employer may have access to some low-fee investments that you might not get on your own. You may also be able to take loans against your account, if needed. Your new employer may also offer a match to your contributions.
If you choose to roll over to an IRA, you’ll generally have access to a wider variety of investment vehicles (like individual stocks, bonds, mutual funds, ETFs, and options), giving you more flexibility to construct your own portfolio that aligns with your investment objectives. You also may be able to take advantage of advisory products or services that will manage your investments for a fee. You can’t take a loan against an IRA account, though you may be able to take penalty-free withdrawals in certain cases to cover education, health insurance premiums, or a first-time home purchase.
If cashing out seems like a necessity due to expenses, you may also want to look at the specific rules of both your old and new employer’s plans. For example, some plans allow for penalty-free withdrawals for certain expenses. Also, if you separate from your employer during the year that you will reach age 55 (or older), you might be able to take penalty free withdrawals if you stay in your plan (although distributions will still be subject to regular taxes). And some plans allow you to borrow from your account, usually with the requirement that you pay yourself back, with interest. Knowing the details may help you choose an alternative that helps preserve your 401(k) savings while helping to address the need for cash.
With all the possibilities available for your old 401(k), you should consider talking to an accountant or tax advisor before taking action so you can better understand any tax implications. And as you progress through your career, make sure you continue to consider choices for your old 401(k)s that help you make the most of your savings.
How much do you need to save to reach your retirement savings goal? Find out by answering a few questions.
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