 | | | Taking a Distribution: The Cost of Cashing Out | | There are two big mistakes you can make when you lose or leave your job. The first mistake is to burn your bridges. Although you may not like your former boss, you never know when you will need him or her for a reference. The second mistake is to cash out of your retirement plan. That can be sure way to derail your long-term retirement goals. | |
| When you leave a job, you have the option of pocketing the money in your retirement account or rolling it over to an IRA or another qualified retirement plan. The former might seem like a great idea. After all, you worked hard for that money and now you have a chance to use it for something fun, such as buying a new car, or for something useful, such as paying off your credit cards. | |
| But while taking that cash now could improve your life in the short-term, it could seriously cripple your long-term retirement plans. If you've been at your job for a while, your retirement plan in all likelihood makes up a large portion of your retirement savings. By zeroing out your account, you're essentially starting over on your retirement savings. | |
| And whether you've been at your job for a dozen years or a dozen months, the cash in your plan could continue to earn even more money if kept in a tax-sheltered account such as a Rollover IRA or your new job's retirement plan. The longer you can keep your dollars working for you, the more you will wind up with at retirement–which means even a small amount could grow into something substantial. For example, a $3,000 retirement account earning a modest 7% annual return could nearly quadruple–to $11,600–in 20 years. | |
| If the thought of all that retirement cash isn't enough to deter you, know this: You won't wind up with all the bucks shown on your account's quarterly statement when you cash out anyway. Here's why: | |
| Taxes. If you contributed pre-tax, you didn't pay any income tax on the money you stuffed into your retirement account. Once you take it out, though, you'll have to give the IRS its due. And if your check is large enough, it could force you into a higher tax bracket, meaning you'll owe even more taxes. | |
| Penalties. Not only will the government take taxes out of your distribution, if you're 59 1/2 when you leave, it will nick another 10% in early withdrawal penalties from whatever's left. | |
| If you are going to rollover your account into an IRA or another qualified retirement plan, you must complete that rollover within 60 days of receiving the check from your former employer; otherwise the IRS will tax the entire amount. As a side note, your former employer is required to withhold 20% of your account balance as a prepayment for federal income taxes. Although you will have to make up that difference when you rollover, you will get it back the next time you file your tax return. | |
| One way to avoid this hassle (and the temptation of cashing the check to buy a new car) is to ask your employer for a direct rollover. In this case, the check is made out to the qualified plan or IRA custodian, rather than to you. | |
| Another option may be to leave the money in your former employer's plan, not a bad option if you are happy with the funds in the plan and how the plan is being administered. Some plans, however, require that you rollover your assets. Check with your plan administrator to see what options you have available. | |
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