Keep Your Money Invested

"Cashing out" means you take your money out of a tax-deferred retirement savings account. Why would you do that?

  • You've got a new job and want to use the money in your former employer's retirement plan to pay off credit cards.
  • You've gone from two incomes to one because your spouse was laid off.
  • You want to buy a new car or take a vacation.
  • You pull out of growth investments because you're tired of losing money in a down market.

Avoid cashing out your savings because you'll generally pay a 10% penalty if you're under age 59½, plus you'll pay taxes on the money you took out. More important, you're giving up continued tax-deferred growth of those savings.

Here are two scenarios:

  1. John has an $18,000 balance in his former employer's 401(k) plan. He decides to cash it out and pay off his car. Taxes and the early withdrawal penalty take $7,200 of his $18,000, leaving him with $10,800.
  2. Instead, he decides to keep that $18,000 in a 401(k) or put it in a rollover IRA. If John averages a 6% rate of return over 32 years, he'll have $116,161 at retirement.

Your retirement savings should stay invested until you retire.


Next steps

If you have an immediate need for cash:

  • Read about distribution options.
  • Talk with your financial advisor before taking money out of your retirement savings plan.

Use the 401(k) Spend It or Save It Calculator to see how much cashing out retirement savings can cost you over time.

This information is not intended as tax advice. Investors should consult a tax advisor.

When the time comes to take money from your retirement plan — either because you're changing jobs or retiring - you'll need to decide what to do with your retirement savings.

You have several choices for handling an eligible payment, or distribution, from your employer's retirement savings plan:

  • Cash out your money in a lump-sum distribution.
  • Keep your money in your former company's plan if you're satisfied with your investments. If you have less than $5,000 in the plan, you may not be able to leave your money there.
  • Roll your savings over to your new employer's plan if it accepts rollovers.
  • Rolling your savings over to an IRA.

Any cash distribution that isn't rolled over to an eligible retirement plan within 60 days of distribution is subject to income tax and, possibly, a 10% early withdrawal penalty if you're under age 59½.

This table compares considerations for each distribution option.

Compare Your Retirement Savings Distribution Options
Choose a
Rollover IRA
Move to your new
employer's plan
Leave in your former employer's plan Cash out
Benefits for you
Preserves tax advantages

No tax penalties

Potentially more investment choices

Early distribution withdrawal options for certain situations

Flexible distribution options

Potential estate planning benefits

Professional investment assistance

 

Consolidates retirement assets

Preserves tax advantages and avoids early withdrawal penalties

May be eligible to take withdrawals at age 55 in certain situations

May provide loan provisions
Ease and simplicity

Preserves tax advantages and avoids penalties

May be able to take withdrawals at age 55 in certain situations

May provide loan provisions
Easy access to assets
Things to consider
No loan provisions

On-going contributions generally not permitted

Required minimum distributions (RMDs) begin at age 70½

Expenses and fees may be higher
Potentially limited investment options

Potentially limited withdrawal options

Subject to all provisions of new plan

Generally, no professional investment assistance provided by plan

Generally, RMDs begin at age 70½; plan may permit non-owner employees to delay RMDs until after 70½ if they continue active employment
Potentially limited investment options

No consolidation of retirement assets

You may have to contact your former employer for any questions or help

Generally, no professional investment assistance provided by plan

Generally, RMDs begin at age 70½; plan may permit non-owner employees to delay RMDs until after 70½ if they continue active employment

 

Entire amount is taxed as ordinary income

Loss of tax-deferred growth potential

10% early withdrawal penalty if you're under 59½

State and local taxes may be due

20% mandatory up-front federal income tax withholding

Rollover IRAs

You may want to consider rolling over your savings to an IRA for these reasons:

  • You can use a rollover IRA to keep any eligible funds growing tax deferred until you're ready to withdraw them.
  • There are no limits on the amount you can roll over.
  • If you have your tax-deferred account distribution rolled over directly from the employer plan to a traditional IRA, the transfer won't have income tax consequences.

Direct rollover to a traditional IRA

A direct rollover to a traditional IRA is the easiest way to roll over your retirement savings and avoid income tax concerns. The plan trustee completes the rollover.

  • You won't be taxed until you withdraw funds from the rollover IRA.
  • Your money will continue to grow tax deferred.
  • If you have a designated Roth account within your employer's plan, you can't roll over those account assets to a traditional IRA.

Direct rollover to a Roth IRA

You can roll over your designated Roth account assets directly to a Roth IRA.

  • Your money will continue to grow tax deferred.
  • You'll be able to withdraw both your contributions and earnings tax free during retirement if you meet the tax law's requirements.

Roth IRA conversion

You can roll over a non-Roth retirement plan account directly to a Roth IRA, but it's complicated and involves tax consequences.

  • You'll pay income tax on pre-tax or deductible contributions you and your employer have made to the plan account and on account earnings you roll over.
  • If you pay these taxes from your plan account, you'll have less money to invest in your Roth IRA.

Whether a Roth conversion is right for you depends on numerous factors, but, in general, a Roth IRA may be beneficial if you:

  • Think you will be in the same or a higher tax bracket when you retire than you are now.
  • Have some time until you plan to retire. The younger you are, the more you generally benefit.
  • Currently have a low account balance but expect the value of your account assets to significantly appreciate in the future.
  • Don't think you'll need to use all of your retirement savings. Converting to a Roth IRA could allow you to provide your beneficiaries with income-tax-free funds.

Company stock

If employer stock in your retirement plan account has increased in value since you bought it, you may want to consider using a net unrealized appreciation (NUA) strategy to reduce your overall taxes.

  • You receive the company stock as part of a qualifying distribution rather than rather rolling it over to an IRA.
  • You pay ordinary income tax only on the plan's cost basis in the stock — basically, the purchase price.
  • When you eventually sell the stock, you pay taxes on the NUA — the difference between the shares' cost basis and their market value at distribution — at lower long-term capital gains rates regardless of how long you've owned the stock in the plan.
  • If the stock increases in value after you receive the shares, the gain is taxed at either the short-term or long-term capital gains rate, depending on how long you've held the stock.

You may also have the option of receiving your retirement benefits in instalments or as an annuity.


Next steps

Retirement plan distributions are complex and can have a significant effect on your retirement savings and tax situation.

Before taking a distribution, talk with your financial and tax advisors to make sure you understand all the implications.

These calculators can help you with your IRA decisions.

Log on to irs.gov/Retirement-Plans/Plan-Participant,-Employee to learn more about retirement plan distribution options.

This information is not intended as tax advice. Investors should consult a tax advisor.

Saving for retirement is a long-term commitment that is most effective when your money stays in your retirement account. You may, however, need to tap retirement money at some point. Here are some other distribution options if you must pull money out of your retirement plan. Your plan may not offer some of these options.

IRA rollover

If you're under age 59½, rolling your retirement plan distribution over to an IRA may help you avoid paying the 10% early withdrawal penalty if you need money for these expenses:

  • Qualified higher education and certain medical expenses.
  • Health insurance premium payments if you've been unemployed for 12 weeks or longer.
  • Qualified distributions for military reservists and members of the National Guard.

72(t) payments

This option — known as substantially equal periodic payments (SEPPs) — allows you to withdraw money from your retirement account before you reach age 59½ without paying the 10% early withdrawal penalty. You may want to consider this method of distribution if you plan to retire early.

Here's how it works:

  • You take a series calculated to distribute your retirement assets over your life expectancy or the joint life expectancies of you and your designated beneficiary — at least annually.
  • You take these payments for five years or until you reach age 59½, whichever occurs later.
  • You can stop the payments once you've taken them for five years and reached 59½.
  • You pay income taxes on the payments.

Loans

Your employer's 401(k) plan and other types of qualified plans may allow you to take a loan from your retirement savings. Note that:

  • Loans aren't allowed with IRAs.
  • You don't pay taxes or early withdrawal penalties on loans from 401(k) plans unless you default on the loan.
  • You pay interest on the loan.
  • Taking a loan can potentially reduce your retirement savings significantly because you lose the tax-deferred growth potential of the money you take out.

Financial hardship withdrawals

Your employer's 401(k) and other types of qualified plans may allow you to take a financial hardship withdrawal if your situation meets certain criteria. Financial hardship withdrawals may be made for these reasons:

  • A primary home purchase
  • Annual higher education expenses for you, your spouse, your dependents or children (even if they are no longer dependent upon you)
  • Prevention of foreclosure on your primary residence or eviction from your home
  • Severe financial hardship
  • Tax-deductible medical expenses that aren't reimbursed

Note that:

  • You can have no other assets available to meet the hardship need.
  • Distributions generally come only from contributed elective deferrals, not earnings.
  • Withdrawals from an IRA may have tax consequences, but you won't have to pay an early withdrawal penalty if you're under 59½ and use the money for higher education expenses or purchase of your first home.
  • Taking a hardship withdrawal can potentially reduce your retirement savings significantly because you lose the tax-deferred growth potential of the money you take out.
  • You can't return 401(k) hardship withdrawal money to your retirement account once payment has been made.

Nonfinancial hardship 401(k) withdrawals

Your employer's 401(k) and other types of qualified plans may allow you to take a nonfinancial hardship withdrawal for these reasons:

  • You become totally and permanently disabled.
  • Your medical debts exceed 7.5% of your adjusted gross income.
  • A court order requires you to give money to your divorced spouse, a child or a dependent.
  • You are laid off, terminated, quit or retire early in the same year you turn 55 or later.
  • You are permanently laid off, terminated, quit or retired and have established a 72(t) payment schedule.

Note that:

  • You pay income taxes on nonfinancial hardship withdrawals but not the 10% early withdrawal penalty.

Next steps

Taking early withdrawals can have a significant effect on your retirement savings and tax situation. Before taking an early withdrawal, talk with your financial and tax advisors to make sure you understand all the implications.

You can use the 72(t) Payments Calculator to estimate payments.

Log on to irs.gov/retirement to learn more about retirement plan distribution options.

This information is not intended as tax advice. Investors should consult a tax advisor.