COLLECTION: RETIREMENT PLANNING

Your 401(k) Are you crazy to cash out

Cashing out your 401(k) could relieve some immediate money worries, but it may have negative long-term effects.

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THE BACKGROUND:

Antiques, wine, and 401(k) balances all have something in common: They can increase in value the longer they sit. Think about it this way: Your grandfather’s antique watch collection may be worth a lot now, but imagine how much it could be worth 20 or more years from now. The same goes for your 401(k). While it can be tempting to use your 401(k) balance to pay down debt or cover other shorter-term expenses, cashing it out prematurely can prove to be a very costly mistake. The Fidelity Viewpoints® article, "Beware of Cashing Out," explains.

THE BREAKDOWN:

Let’s say you just lost your job, and you’re in a little bit of a cash crunch. You have all this money in your 401(k)—just sitting there. It’s no big deal if you dip into it to cover some of your bills, right?

Think again.

While it can be tempting to cash out your 401(k), the costs could be devastating. Let’s talk about them.

The costs:

  • Cashing out comes with an immediate price.
    Your plan administrator will typically withhold 20% of your balance, which is paid directly to the IRS. That means you’re basically handing over a chunk of change that you’ve been working so hard to save. What’s more, investors younger than 59½ (that’s you) will generally have to pay a 10% early withdrawal penalty fee. That means that cashing out $50,000 in 401(k) savings may leave just $35,000 in cash after 20% withholding and a 10% early withdrawal penalty!
  • Cashing out can also have a long-term effect on your savings.
    One of the main advantages of a 401(k) is that it allows your money to grow tax deferred, meaning you don’t have to pay taxes on your investments until you withdraw them. Cash out too soon and you’ll miss out on the full power of compounding (or the ability for your money to generate interest), along with any gains your money may have made if the market goes up.

Alternatives to cashing out:

Now you understand the costs of cashing out. So what are your options? If you’ve left a job and aren’t sure what to do with your 401(k), here are some ways you can keep your savings intact and working for you.

  • Option 1: Stick with your current plan.
    Leaving your money in your former employer’s retirement plan can be an easy, hassle-free move. The downside? You won’t be able to contribute to it any longer or benefit from your former employer’s matching contributions.
  • Option 2: Roll the balance into your new employer’s plan.
    It can be an easy way to keep all your retirement savings under one roof. Just remember to review your new plan’s fees and investment options and compare them with your old plan before choosing this option.
  • Option 3: Consider a traditional IRA rollover.
    The advantage? Your contributions and earnings can continue to grow tax free until you start taking withdrawals. IRAs also typically offer a broader array of investment options. The rollover process is pretty easy, but be sure to request a direct rollover to avoid any taxes or penalties. More on that here.

401k(s) vs. IRAs—important considerations:

Here are just a few of the factors you may want to consider when deciding whether to keep your savings in a 401(k) or roll them into an IRA.

  • Fees.
    Compare the underlying fees and expenses of the investment options in your old and new plans with those in the IRA. Some plans may offer you access to lower-cost or plan-specific investment options. Also, consider any fees charged by the plans, such as quarterly administration fees. Those should be compared with any fees that may be accessed in the IRA. Each IRA provider’s fees are different, so it is important to look carefully at the provider.
  • Investment options.
    In general, IRAs offer broader access to mutual funds and individual securities than 401(k)s do, which may be appealing if you like to handpick your investments. Make sure to do your research before making a decision either way.
  • Liquidity and security.
    Keeping money in a 401(k) could protect your savings more from certain creditors. That said, you may have more access and flexibility in an IRA when you need to withdraw money. Just be sure you understand the rules of your 401(k) plan, since each can vary.

THE BOTTOM LINE:

There are other factors to consider as well, so before you cash out that 401(k), make sure you cash in on some of these tips—and weigh your options before making any decisions. They might help you save yourself from an expensive financial mistake.

Take the next step

Still thinking about cashing out that 401(k)? Give us a call—we can help you weigh your options.

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Be sure to consider all your available options and the applicable fees and features of each before moving your retirement assets.
Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.
The images, graphs, tools, and videos are for illustrative purposes only.
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