As you are no doubt aware, the long and deep recession has resulted in the highest unemployment rate in decades. But if you have been laid off, or if you fear a layoff may soon be coming, you are less interested in statistics than in your immediate financial future. How will you get by until you land a new job?
This is a scary question, of course. And it can cause you to look at all your available financial resources — including your 401(k), which may well be the largest single financial resource you have.
But before you cash out your 401(k), make sure you understand what is involved. Your former employer is required to withhold 20 percent of your account balance to prepay federal taxes. Also, all your 401(k) proceeds will be taxed as ordinary income. And if you are younger than age 59 1/2 when you liquidate your 401(k), you may also be subject to a 10 percent penalty. And worst of all, the money may not be available to you when you retire.
Obviously, if you have no other financial resources, you may have no choice but to tap into your 401(k) plan.
However, if you can find an alternative way to tide yourself over until you are working again, you may be better off in the long run by not cashing in your plan.
If you decide against the “cash-out” option, what can you do with your 401(k)? Here are two possibilities:
Keep the money in your former employer’s plan, if your former employer permits it. You won’t have to pay any immediate taxes, and your money can continue to grow tax deferred. But you may no longer be able to add funds to your account.
Roll your money over to an IRA. If you roll over your 401(k) assets to an IRA, you will avoid paying immediate taxes, and your money can continue to grow tax deferred. Furthermore, you can fund your IRA with many types of investments, as opposed to a 401(k), which may offer only a handful of choices. And when you can afford it, you can make additional contributions to your IRA. Also, when you retire, you may find that an IRA gives you more flexibility in making withdrawals than a 401(k).
While there are some clear benefits to keeping your 401(k) with your former employer or moving it to an IRA, neither choice helps you answer the question of how you’ll make it, financially speaking, until you are working again. If you’ve built up a cash cushion in the preceding years, you can turn to it now, of course. And if you’ve created an investment portfolio outside your 401(k), take a close look at it. You can consider adjusting your investment mix to add more income-producing investments, if appropriate. Keep in mind that your portfolio should reflect your risk tolerance, long-term goals and time horizon.
A layoff is never easy and it can force you to make some tough choices. But if you can help protect your 401(k) today, you will be helping yourself tomorrow.
Diane Tucker, a financial adviser with Edward Jones Investments, 5889 53rd Ave. E., Bradenton, can be reached at (941) 727-0900 or diane.tucker@edwardjones.com.
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