cashing out a 401K how bad is it?

[DISUNC]

Why are some plans able to opt out of the hardship option?

I called this morning to find out how much it would cost to cash out when I leave my present job.(Late next year) I was told it would be 30%. Since our plan doesn't allow hardship withdrawls, I may be stuck paying the 30%.

That is 30% right off the top. There are MORE taxes later to pay!

 

[disneyjunkie]

That is 30% right off the top. There are MORE taxes later to pay!

Sorry, 20% off the top, then 10% when I file my taxes, so a total of 30%.

 

[Chicago526]

Sorry, 20% off the top, then 10% when I file my taxes, so a total of 30%.

Nuh-uh. When they pay out the 401k, they withhold 30% and give you the rest. 20% is for income tax and 10% is for the penalty for early withdrawl. But, if you are in an income tax bracket HIGHER than 20%, you then have to pay the differance between the 20% and your tax bracket. You could still owe more taxes when you file in April. With the extra bump in income you get from cashing out the 401k, you'll likely be in a bracket higher than 20% (although it will depend on your income from employment, how much is in your 401k, and how much you have in the way of deductions). At the absolute best, you most likely won't see a tax refund if you usually get one. At the worst, you could have to write a check for THOUSANDS on April 15.

 

[Chicago526]

Here is an excerpt from a very good explaination of early withdrawl penalties and hardship rules. http://www.401khelpcenter.com/mpower/feature_121902.html

Two types of hardship withdrawals are permitted from 401k plans. One is called a financial hardship withdrawal. It is subject to applicable income taxes and a 10 percent early withdrawal penalty if you are younger than 59 1/2.

The other is a penalty-free withdrawal made under Section 72(t) of the Internal Revenue Code. With this, you pay applicable income taxes but not an early withdrawal penalty.

Financial hardship withdrawals are allowed for the following reasons:

to buy a primary residence (the reason Quaid took his money, and the most common reason folks take hardship withdrawals according to the Investment Company Institute)
to prevent foreclosure or eviction from your home
to pay college tuition for yourself or a dependent, provided the tuition is due within the next 12 months
to pay unreimbursed medical expenses for you or your dependents
You may qualify to take a penalty-free withdrawal if you meet one of the following exceptions:

You become totally disabled.
You are in debt for medical expenses that exceed 7.5 percent of your adjusted gross income.
You are required by court order to give the money to your divorced spouse, a child, or a dependent.
You are separated from service (through permanent layoff, termination, quitting or taking early retirement) in the year you turn 55, or later.
You are separated from service and you have set up a payment schedule to withdraw money in substantially equal amounts over the course of your life expectancy. (Once you begin taking this kind of distribution you are required to continue for five years or until you reach age 59 1/2, whichever is longer.)
Employers are not required to offer either type of hardship withdrawal, so you should check with your employer to see which type, if any, is available to you. This article primarily discusses financial hardship withdrawals.

Withdrawal Process
If you need a new car and want to take a 401k hardship withdrawal for that purpose, think again. These withdrawals are meant for big emergencies. You really have to need the money and have no other source of funds.

In addition to tough federal rules, you may also have to contend with a strict set of withdrawal rules from your employer.

That said, some employers are easing the rules to make the hardship withdrawal application process easier and give plan participants faster access to their cash, said Leslie Smith, a partner with Deloitte & Touche and the coordinator of the firm's annual 401k plan survey.

Employers use one of two methods to issue financial hardship withdrawals. One is a proof of need. In this case, you have to show your employer financial proof that you need to take money out of your 401k. With this method, you are allowed to start contributing to your 401k plan with the next paycheck following your hardship withdrawal.

Many employers don't use this method, Benna says, because they really aren't interested in knowing so much about their workers' private lives. Similarly, few workers are comfortable exposing their finances to their bosses and co-workers.

The other method, called self-certification, doesn't require you to disclose your finances, but plans using this method will not allow you to make fresh 401k contributions for six months after taking the withdrawal. This further limits your ability to build a retirement nest egg.

Loan Alternative
By the end of the year, Quaid found he had some extra cash on hand and wanted to know if he could repay the hardship withdrawal or roll the money into an IRA and avoid the taxes and penalties. The answer is "no."

"Once you take the money out, you can't put it back in," said Deborah Knuckey, author of Conscious Spending for Couples. "You lose for life the tax advantage."

A hardship withdrawal is not a loan. You can't repay it. But, that raises a good point. You should see if your plan offers a 401k loan as an alternative to taking a financial hardship withdrawal. Plan loans are not subject to taxes or penalties, and you can continue to contribute to the plan while you repay the loan. (Some plans will even require you to exhaust your possibilities for a loan before taking a hardship withdrawal.)

However, if you leave your employer before the loan is repaid, you must pay back the remaining balance otherwise it will be considered a withdrawal and subject to applicable taxes and penalties.

When looking for hardship withdrawal alternatives, don't forget savings in your IRA, if you have one. IRS rules allow IRA holders to withdraw up to $10,000 penalty-free when the money is used for qualified first home expenses. (That is a lifetime limit.) Also, you may take penalty-free IRA withdrawals when the savings are used to pay for qualified higher education expenses for you or your spouse, children or grandchildren.

Tax Pain
What many 401k participants, desperate for money, may forget is the cost of taking a financial hardship withdrawal. A $10,000 withdrawal does not equal $10,000 in your pocket.

"If you are under 59 1/2, you will lose 35 percent to 45 percent of the withdrawal in taxes and penalties," Benna said. "You need to think about that."

For example: suppose your tax filing status is married filing jointly and you earn $60,000 a year. That means your income falls in the 27 percent tax bracket.

If you take a $10,000 hardship withdrawal to pay for your child's college tuition, you will owe $2,700 in federal income taxes and an additional $1,000 to cover the early withdrawal penalty. You'll be left with $6,300, or less if you also owe state income tax.

Retirement Pain
Taking a hardship withdrawal can also result in longer-term pain -- a less generous retirement.

Take the example of a person who, starting at age 30, contributes $5,000 a year to her 401k plan. At age 40, she buys a house and takes a $10,000 hardship withdrawal for the down payment. Let's assume her portfolio generates an average annual return of 8 percent. By retirement at age 65, she will have $793,094. Had she not taken the hardship withdrawal she would have had $861,584, or $68,490 more.

A $10,000 withdrawal may seem insignificant today, but over time it can mean a lot. The trouble is making up for it in the account.

"Few people take money out and make the promise to put it back in," said Diane Savage, a certified financial planner with Szarka Financial Management. Even if they do, by the time they get around to it, it's more costly to get the account back to where it should be. That's because the money wasn't working for them while it was out of the account.

 

[mickeyfan2]

Nuh-uh

 

[EthansMom]

As others have mentioned, the money will be taxed at your highest tax rate and also incur a 10% penalty for early withdrawal. You will get only a fraction of the current value of the 401k.

Also, you are more likely to use/spend all of the money rather than use what you truly need and reinvest the remainder. The hit to your retirement accounts could mean a difference of years of income (depending upon the balance of the 401k and how many years until retirement). A $20,000 401k could be worth over $90,000 in twenty years if it earns 8%, for instance.

If at all possible, decrease your spending now and start saving for any downtime between positions. Your DH could try to arrange to have as little downtime between jobs as possible so that he doesn't have a gap in pay checks (he could get the last paycheck from his former job while working for the new employer).

Roll the 401k directly over to a Traditional IRA. Have the check made out to the IRA company.

Good Luck!

 

[binny]

Thank you all for your advice. At this point Im just trying to figure out our options. I know the 401K is one of our last options.

Thanks again!