Cash Out 401k Tax Penalty
When faced with a sudden requirement of cash, one can find it tempting to withdraw from his 401(k). There can be several situations where one can think of tapping his 401(k). It may be any medical emergency or any other sudden cash crunch. Even when leaving a job and having a 401(k) just hanging around, one typically has the option to cash out his 401(k). But premature withdrawals levy certain penalties that may result in losing some of the saved money.
Employers impose restriction on withdrawals from 401(k) while a person is employed with them and is under age 59 1/2. Any withdrawal that is permitted before age 59 1/2 is considered a pre-mature withdrawal and is liable to an excise tax which equal to 10% of the amount withdrawn. In addition, one will have to pay fedaral taxes on the full amount of the withdrawal, which comes around 30-35%.
One can calculate the pre-mature withdrawal penalty for 401(k) withdrawal. Suppose one is 40 years old and has $50,000 and has to go for cashing out his 401(k). A withdrawal like that would guarantee him in the 27% federal tax bracket which comes to around $13,500 or even higher. Then a 10% penalty which comes to be $5,000. One now will be left with around 60% of his cash out IRA (around $30,000). State income tax will possibly cost another $2,000-$3,000.
There are several reasons people may choose to cash out their 401(k) instead of saving the money for retirement. A common reason might be the increase in health insurance premiums. People aren't used to paying several hundred dollars a month to insure their families. Insurance costs, combined with a loss in stock value or other investments, make people feel the need for extra money. They also believe that they'll make up for it down the road.
There are some means that can save the penalties of cashing out a 401(k). One can take out a loan from his 401k to avoid penalties associated with early withdrawal. State and federal tax regulations allow one to borrow funds from one's retirement account in limited circumstances without income taxes or penalties. Another good way out is to pay off medical bills not insured by one's employer's plan with principal from his account. These withdrawals do not accrue penalties or income taxes.
However, there are options that people can look for instead of going for a cash out of their 401(k). By rolling over the 401(k) into an IRA, one won't be limited by the investment options in a new employer's plan and can take distributions from the IRA without penalties under certain circumstances. Another good option can be ollover a portion. It doesn't have to be all or nothing. This can be rollover only a portion of the 401(k) savings. It is quite good for those who need money now, but realize they will also need it later.
