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Leaving a Job
Cashing Out
As tempting as it is to take the money and run, taxes and penalties usually outweigh the benefits of instant cash. This is usually considered the worst option you can choose, and here’s why:
If you’re plan is to take the cash and head to Hawaii, the vacation might be fun, but the taxes and penalties are really going to hurt. Taking that money means you’ll owe income taxes on the full amount and if you’re under 59 ½ you’ll also owe an additional 10% penalty for taking the money early.
Maybe you don’t want to spend the money, but you’d like to take the cash and look for a good place to put it. After all, the law does give you 60 days to reinvest it in an IRA or another employer’s plan.
Here’s why that’s not such a good idea:
If you take the “cash in hand” even though you intend on reinvesting it, your former employer is required to withhold 20% of your account value. Now, you still have 60 days to reinvest that money, but when you do find the IRA or new plan to put it into, you have to put in 100% of your original account value, not the 80% that you walked away with.
If you’re not able to come up with the missing 20%, then that amount is treated as a distribution, and…you guessed it… you get to pay income taxes and possibly that 10% penalty on that money.
Here’s an example:
Let's say you have $100,000 in your 401(k) plan. You decide to cash out the money. Your plan administrator will automatically withhold 20% for taxes as required by law.
You receive a check for $80,000.
Now, the problem is, at the end of 60 days, you have to have $100,000 to reinvest in an IRA or new employer’s plan. If you only have the $80,000 they gave you, you’ll owe income taxes on the missing $20,000 and if you’re under 59 ½ you’ll also owe 10%.
In a 31% federal tax bracket, you’ll owe $6,200 in federal income taxes, PLUS an additional $2,000 if you’re under 59 ½.
You end up paying Uncle Sam $8,200 just because you took a check in hand when you left your job.
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