If you’re thinking about changing jobs and are tempted to cash in a portion of your 401k plan or all of it there many things you should consider. According to Forbes employee turnover rate is the highest it’s ever been in 10 years causing many to tap into their retirement plans for non-emergencies.
When you dip into a 401k plan prior to age 59 ½ you’re subjecting yourself to a Federal tax penalty of 10% on top of ordinary income tax so it would be wise to consider all of the consequences of cashing in any portion of your 401k.
When you leave one job to start another you have a few options to choose from. One option is to leave your plan where it is. Another option is to transfer your 401k from the previous employer to the new 401k plan offered at your new job. Then there is the option to rollover your 401k into an Individual Retirement Plan (IRA) where you have more control.
If you’re in need of funds and are tempted to tap into your retirement savings you need to do the math on what that will cost you factoring the 10% penalty imposed by the IRS for early withdrawals. An alternative would be to consider a loan from your current plan. About 94% of companies with 401k plans allow to you to take out loans against the contributions you’ve made into the plan.
Even though it’s considered your money you still have to pay an interest rate on the funds borrowed. The plan administrator will usually set an interest rate of 1%- 2% over the prime rate which is currently at 3.75% which is more advantageous than the penalties you would incur plus being taxed at an ordinary income tax rate.
Any loans from a plan are not taxed at all (if repaid by the barrow). Now if the loan is not repaid when you separate employment then it will be considered a distribution taxed as ordinary income and a penalty would be applied if under 59 ½.
Taxes and penalties can easily erode a good portion of your retirement savings that you’ve worked hard to accumulate and a qualified plan is usually the last place you want to dip into early.
If you decide to take the hit and pay the tax and penalties then it may be wise to consider another vehicle to fund like a properly designed Indexed Universal Life (IUL) policy that has a cash value. The cash value in this type of policy is linked to an index like the S&P 500 with no risk since the underwriting insurance company assumes the risk.
You can take loans against the cash value when needed 100% tax-free and you don’t have to wait until 59 ½ or have to repay the loan since it will be taken against the death benefit.