You may want to retire early and you have money sitting in a pension fund or 401(k) plan. While the cash is there working for you, it may be tempting to cash it in. However, you will be hit with an automatic tax for withdrawing it, and if you're not considered old enough to retire, penalties may also be added. Between the taxes, penalties and any lost investments or employer-matching funds, you may want to consider other options before cashing in your pension.
Whether you're pulling money from a pension, 401(k) or IRA, the Internal Revenue Service treats it as income. From there, the only real difference is when you're billed for income taxes. If you cash out on a 401(k), 20 percent is withheld immediately. With a traditional IRA, a withdrawal is still treated as income, but the tax is levied at the end of the year. The only exception is if it's a Roth IRA, where you pay the taxes up front.
Early Withdrawal Penalty
In addition to income taxes, your 401(k) or traditional IRA administrator penalizes you by taking out an additional 10 percent early withdrawal penalty. This means when you draw your check, 30 percent is taken out -- a significant amount of money. This penalty is added if you take the cash before you turn 59 1/2 years old, your full retirement age for a 401(k) or traditional IRA. With a Roth IRA, you can withdraw any of the money you put into it without penalty.
If an "immediate and heavy financial need" forces you to withdraw the money before you reach full retirement age, the 10 percent penalty is waived. However, it's up to a 401(k) administrator to decide what qualifies as a financial hardship. According to federal tax law, this may include illness, avoiding eviction or buying a first home. A traditional IRA has different rules from a workplace plan, with a looser definition of a hardship.
If you're still working for the company sponsoring your 401(k), you can borrow from your account without taxes or penalties. But since you're borrowing -- even if it's your own money -- you still have to pay it back. If you leave that job before paying it back, your plan administrator has the right to call the loan for immediate repayment. However, borrowing against your 401(k) is the only way you can get money out early if you're still working for the company.
If you change jobs, you can move the money from your old 401(k) to your new employer's plan without penalty. This can be done electronically as a direct rollover. If the plan administrator writes you a check for your 401(k) as part of an indirect rollover, you have 60 days to move the money into another 401(k) or IRA without taxes or penalties.
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