Typically, when people cash out their 401k, they have lost their job and or are switching jobs. More often than not, these people simply don’t understand their options and see quick cash in sight. However, if you understood the immediate cost of cashing out and the opportunity lost if you would have rolled it over into an IRA or something similar; you would see how cheap, reckless and stupid that benefit of cash in hand now is. More or less, you get quick cash a major cost now and to your future. I understand that in many cases you need that money now, things may be tight and you just flat out need it, but listen to me here, decide if you really do:
Let’s say you have $10,000 you’ve built up in a few years or so, and you’re getting a new job or have been let go. If you decide to cash out instead of rollover your 401k into an IRA you will pay the following:
Your 401K $10,000
Less (Early withdrawal 10% Penalty) 1,000
Less (Assumed 25% Federal taxes) 2,500
Less (Assumed 6% State taxes) 600
At the time your disbursement is made, your employer will only deduct 20% mandated by the IRS as prepayment towards your federal income taxes. You will still have the additional penalties and taxes due at tax time (whatever additional federal and state taxes and early withdrawal fees).
Note: The 10% only applies if you withdrawal before you turn 59 1/2.
As you can see in the example above, only 20% will be deducted at the time of disbursement, you will still have to pay more. So, out of that 10,000 you thought you would get back, you really only got back 59%. Compare that to rolling over your 401k into an IRA, and letting that money continue to work for you. Say you were 30, and left that money alone until you turned 60. It would have been worth (assuming a 10% return) around $175,000. This is saying, I would have lost $165,000, not adding a dime to the initial $10,000 if I would have just left it alone.
As you can see, that $5,900 is nothing compared to just leaving it alone. In the end, it’s your choice, is it really worth it?