Cashing out an old 401(k)

No matter the need, it’s never really a good idea

Question: I know that cashing out a retirement account isn’t a great choice, but does it ever make sense? Say, if I have a lot of high-interest credit-card debt or if I have no other way to pay bills?

Answer: The short answer is no. Unfortunately, more than one-third of Americans end up cashing out their

401(k) after leaving a job. Generally speaking, cashing out a

401(k) should be seen as a last resort. Let’s say you have $20,000 in a

401(k) from your former employer. Cashing out will trigger a 10 percent penalty from the IRS if you’re younger than 591⁄ years old, plus you’ll have to 2 pay income taxes on the withdrawal. Let’s assume you’re in the 22 percent marginal tax bracket for federal income taxes and 5 percent for your state. All of a sudden, your $20,000 becomes

$12,600.

So even if you have high-interest credit-card debt, it’s probably a bad idea to cash out. You’re taking a 37 percent haircut on your savings to pay it off.

Even worse is what would happen to that $20,000 if left alone. If you’re 35 now, leaving it alone until you’re 65 would result in more than $152,000, assuming 7 percent annualized returns. The choice between $12,600 now or more than 12 times that amount when you retire seems like a no-brainer.

A gray area arises if you’re having serious financial hardship. In situations such as these, it can make sense to consider cashing out, but only if you’ve exhausted every other reasonable option.