Don’t Short-Change Your Future By Cashing Out Your 401(k)

If you’re looking for money to buy a new car or pay off some bills, your 401(k) plan may seem like a pot of untapped gold.

The temptation to tap your retirement funds often comes when you switch jobs and must decide how to handle your account. But in most cases, breaking into a retirement plan early is a mistake that will just melt away your savings.

Unfortunately, many people make the unfortunate decision to “cash out” their retirement accounts when they leave their jobs.

Let’s say you’re taking a new job and you need $15,000 to buy a new car for commuting. Taking the money from your 401(k) account will hurt you in two ways:

1. You’ll lose future retirement funds. This is money that could continue to build up while remaining tax-deferred.
2. You’ll pay a big tax price. Combined federal and state taxes and penalties can take away as much as 50 cents on every dollar withdrawn early. You might have to withdraw $30,000 to get the $15,000 you need.

This is an extremely expensive way to finance a car. You’re better off getting a conventional car loan.

A smarter move: Roll the money over into another tax-deferred account, such as an IRA or your new employer’s qualified plan.

Another option: If you desperately need money, look into borrowing against your 401(k) balance, rather than withdrawing the money outright.

In any event, it’s a good idea to consult with your financial advisor before making any moves with this money.

This post appeared in our 2/16/2022 issue of The Bottom Line.