Consequences to consider before cashing out of your retirement plan
One option available for your retirement plan savings after leaving an employer is to take your balance in cash, either as a check or a direct deposit to a bank account. This may seem to be an attractive option—or in the case of a job loss or other severe financial emergency—it may be quite necessary. But a cash withdrawal comes with substantial costs that you should know about before making any decisions, especially if you’re under age 59½. Here’s a quick review of the particulars of these costs and how they could affect your retirement nest egg.
Tax withholding means you’ll get less than you ask for
When you request all or part of your plan savings in cash, you may receive considerably less than you’re planning on. That’s because a portion of the proceeds will be withheld to cover income taxes. This includes:
Mandatory withholding to cover your federal taxes. Twenty percent will be deducted from your withdrawal and sent to the IRS to help cover the federal taxes you’ll owe.
Possible state tax withholding. Not all states have mandatory state tax withholding. If yours does, then an additional amount will also be withheld from your cash withdrawal. See your state’s department of revenue website to see if your state requires withholding on withdrawals from employer-sponsored retirement plans.
Your tax bracket will determine how much tax you actually pay
Because the IRS taxes retirement withdrawals as ordinary income, the rate you actually pay will depend on your total annual earnings. This may be higher or lower than the 20% withheld.
Generally speaking, you’re also subject to a 10% tax penalty if under age 59½ when you take your withdrawal, although there are some exceptions.1
State income taxes (if any) are additional.
The other cost of a cash withdrawal—less for retirement
Taking cash from your retirement account will immediately reduce the money potentially available to you in your retirement years. What’s more, you’ll lose out on future potential investment growth. On the other hand, keeping your savings in your former employer’s retirement plan—or rolling it over to a new employer’s plan or an IRA—could help keep it growing tax deferred until you withdraw it.2
What happens when you cash out a retirement plan early?
This hypothetical example is based on cashing out a retirement plan account 20 years before the expected retirement date.
This is a hypothetical illustration for informational purposes only. It reflects a 25% federal income-tax rate, a 5% state income-tax rate, and a 10% IRS early withdrawal penalty on the cash distribution amount. It also assumes a 6% average annual return on the rollover and reinvested cash distribution. For illustrative purposes only. Not indicative of any particular investment. Past performance does not guarantee future results.
Cashing out $20,000 today would give you $12,000 after taxes and penalties. Even if you invested the cash for 20 years in a taxable account, it would be hard to make up the $8,000 loss.
Rolling over $20,000 into a new employer’s plan or IRA today allows for continued growth and may be worth $44,900 (after taxes) in 20 years.
Seek guidance before you decide
Whether it’s staying in your former employer’s retirement plan, rolling over to a new employer’s plan or an IRA, or taking some or all of your money in cash, keep in mind that every option has its advantages and disadvantages. To better understand your options for your retirement savings, consider consulting a financial professional or tax advisor.
1 See the IRS's chart on exceptions to tax on early distributions at www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-exceptions-to-tax-on-early-distributions. 2 There are advantages and disadvantages to all rollover options. You are encouraged to review your options to determine if staying in a retirement plan, rolling over to an IRA, or another option is best for you.
Important disclosures
The content of this document is for general information only and is believed to be accurate and reliable as of the posting date, but may be subject to change. It is not intended to provide investment, tax, plan design, or legal advice (unless otherwise indicated). Please consult your own independent advisor as to any investment, tax, or legal statements made.
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