You’re leaving your current employer because you’ve got a new job, but it may be some time before you get your first paycheck from your new employer. Or perhaps you’ve become a victim of downsizing, and are just now beginning a job search. In either case, you might be facing a short-term cash crunch. When you review the options available to you for your existing 401(k) plan, “cashing out” your vested 401(k) balance might seem like the perfect solution.
Don’t do it. At least, don’t do it without really understanding your options. Taking a lump-sum distribution is a bad choice for most people. Why?
- First, you’ll have to pay taxes on the funds you receive, and those funds will no longer grow tax deferred.
- Second, if you’re under age 59 1/2 (under age 55 in some circumstances) you’ll have to pay an additional 10% premature distribution tax.
- Most importantly, though, you’ll be dealing your retirement savings a severe blow.
So what should you do? You generally have the following options:
- Do nothing — keep your funds in your old employer’s 401(k) plan if you like the investment options available in the plan (you might not have this option if your vested balance is $5,000 or less).
- Transfer the funds directly (a “direct rollover”) to a traditional IRA that you already have or that you establish for this purpose.
- Transfer the funds directly to your new employer’s 401(k) if the plan allows you to do so.
In all three cases, your funds will continue to grow tax deferred. When it’s time to retire, you’ll thank yourself.