cost of taking retirement money early
My plant is closing for good and I am going to
roll over my company 401(k) into an IRA as soon as my company notifies
me of my separation date. The scenario is this: The IRA is at my
credit union and the rollover transaction is successful at my credit
union on Sept. 1, 2004. How quick can I get my money when I tell
my credit union on Sept. 2, 2004, that I want to cash the IRA out?
Also, what are the penalties for cashing in my IRA at this point?
I know I avoided the 20 percent right off the top by not cashing
it in from my company and taking the money directly. I was told
to roll over my 401(k) into an IRA first and then cash it there
to avoid more severe penalties. Is this correct? This will involve
a six-figure amount. Thanks.
There are a lot of complications in your situation, as well as opportunities
for planning, especially since the IRA is in the six figures. You
definitely don't want to make a costly mistake that cuts into your
It's true that if you take a direct payment from the
401(k) plan, you'll be subject to 20 percent withholding. You need
to determine whether you really do need all that money at once.
If you put it into the IRA, you might avoid part of
the withholding, but the bank might withhold 10 percent if you're
under age 59½. The 10 percent represents the penalty for
early withdrawal that wouldn't apply to the 401(k) distribution
if you're age 55 or over when you leave the plant.
Since you're unemployed, you may avoid part of the
penalty if you incur medical insurance costs and the money is in
an IRA. The remainder of the withdrawal is taxed at ordinary income
tax rates, which can be as high as 35 percent, depending on
your other income.
Your best opportunity for planning depends on what
you'll do when you're laid off. If you're thinking of starting your
own business, then you might be able to take advantage of the 401(k)
money to help you start that business and not pay any taxes on the
Let's say your dream is to open your own business
and you need $20,000 to get started and that money is in your retirement
plan. What you can do is start your own retirement plan for your
new business and roll over your 401(k) to that plan. The plan that
you establish will permit participants, namely you, to borrow funds
from their vested balances. You can borrow up to $50,000 or half
of your vested balance and not pay tax on the borrowings.
In addition, you can defer making contributions into
the plan until the business has profit. While the setup costs of
this idea may run $1,000 in professional fees and costs, it's certainly
cheaper than the tax penalty you may owe.