If you recently lost your job, you may be wondering what to do with your 401(k) account. Even if you haven’t lost your job, you may still be wondering what to do with it, as many employers have stopped offering to match contributions or have eliminated the program entirely.
In most cases, you have 2 options:
- Rollover your account to an IRA
- Cash out your account
Cashing out may be tempting in the face of reduced income, an uncertain future, but all the usual bills. You should avoid cashing out if at all possible, though–when you cash out you will pay:
- A 10% penalty
- Taxes on the amount (see 2009 Marginal Tax Brackets for your rate–it will most likely be 15 or 25%).
You may end up seeing only $650 for every $1000 in your account. Ouch!
Nearly all banks and credit unions offer IRA accounts. You can also get an IRA account through an investment management company like Vanguard, although their minimum investments may be substantially higher. A 401(k) rollover to a traditional IRA will incur no penalties, and you won’t pay taxes until you start taking distributions in retirement.
Other advantages of an IRA? You can take distributions without penalty (though you still have to pay taxes) for qualifying medical expenses, higher education expenses, and a first home purchase. It is also not at risk in the event that you have to declare bankruptcy (which is unlikely, since you are, without a doubt, a clever job hunter).
There are a few cases where it may make sense to cash it out. For example, if the penalty+tax is 25% and you have credit card debt with a 32% interest rate, it makes sense to cash out and pay off the debt.
(Remember that the value of your retirement account should be going up–if you expect a 7% return, then you are losing that return plus the 25% in penalties and taxes–which makes paying off that high-interest credit card seem like an even exchange. I would still lean towards an IRA rollover, though, because the IRA probably has a longer time horizon than your credit card bill.)
Also, if you don’t have a lot of savings and are not eligible for unemployment compensation, it may make sense to cash out your retirement account so that you are not immediately faced with the prospect of late payments and other financial mishaps. If you have a substantial 401(k) balance, you should be able to cash out just a portion of it, while rolling the remainder over to an IRA.
Hang on to that retirement account if you can!