A 401(K) is an employer-sponsored retirement plan. Every month you make a contribution to the retirement plan, which is matched by your employer. This allows money to be saved over a long period, which would help to create a fund to be used post-retirement. You can cash out the 401(k) if you need the money or change jobs. Here’s how you can do it easily.
Why cash out?
If you change jobs, you may want to cash out your 401(k). You may also decide to cash out if you are in urgent need of money. The factors on which your cashing out would depend are – your age, the rules of the 401(k) plan and whether you are employed with the employer who sponsored your 401(k).
How to cash out?
First and foremost take a decision on whether you need to cash out or would want to wait until you reach the retirement age. In an ideal scenario, waiting till you retire is advisable. After all, this is a retirement fund. But we don’t live in an ideal world and you may not be in a position to wait till retirement and may need money. In such a case, let’s see how to cash out.
This is the standard withdrawal that happens after age 55 (in some cases it may be 59½). Here, you can take out your money easily by contacting the plan administrator who will advise you on the procedure to be followed. Once you get the money, you need to note that you need to pay income tax on it as per the prevailing rules.
If you opt for an early withdrawal, it can be done easily. But you must note that there are consequences. Firstly there would be penalty levied by the plan administrator. This is done to prevent early withdrawals. After all, if everyone withdraws early, how can the plan make money? So, a penalty of 10% is levied[i]. Then, of course, you have to pay taxes – federal income tax as well as applicable state taxes. This would be costly. You may lose almost 40% of your retirement fund to taxes and penalty. So early withdrawal has costly consequences. There is an alternative though, which is rollover IRA.
What is rollover IRA?
If you want to avoid the 10% penalty for early withdrawal, then you can rollover your 401(k) account to an IRA or Individual Retirement Account.
Shifting over to an IRA has many advantages:
- You can avoid paying the penalty payment fee by using an IRA under a special rule known as 72(t).
- Most importantly you don’t have to pay taxes, whether Federal or state.
- They are easy to setup and do not require any complicated paperwork or procedures to be followed.
- Once the IRA is setup, you can withdraw how much ever money you want from it. You need to pay taxes only for the money you withdraw.
One more point to be kept in mind is, if you need money urgently while being employed, you can take a loan against your 401(k). This will allow you to get money and also avoid using up your retirement money early.
Early cashing out of your 401(k) plan can lead to penalties and higher taxes. It thus makes sense to create a rollover IRA when you cash out your 401(k).