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Friday, October 31, 2014

114. Should I cash out my 401k to pay debt?

I read recently “Should I cash out my 401k to pay debt?”

The answer is: No! Don’t cash out your 401k!

According to a recent article in February 2014 with data compiled by Fidelity one in three 401k participants have cashed out of his or her plan, often when changing jobs.

Cashing out a 401k is an easy way to generate a short-term cash need. But it’s a bad idea.

If you invest $5,500 that investment in an IRA could grow to over $58,000 in a period of 35 years.

If you do cash it out typically your plan administrator will withhold 20% of the balance and sends it to the IRS to core the taxes you'd pay in a withdrawal. 

On top of that investors younger than 59 1/2 who cash out may face an additional 10% early withdrawal penalty. 

So in essence you'd pay a 30% "stupid tax" as Dave Ramsey calls it.

What you CAN do is apply for hardship withdrawal with the IRS from your 401k, 403b, or 457b but that can be tricky. You'd still have to pay income taxes and likely an additional 10% penalty.

When switching jobs instead of cashing out your 401k consider rolling it over into a Traditional IRA, Roth IRA, or stick with another 401k.

My personal 401k which I rolled over in my previous job has more than tripled in value in the last 3-4 years.

Have you considered cashing out your 401k? When switching jobs did you rollover to another 401k? Or did you rollover into a Traditional or Roth IRA?


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