Cashing out your retirement plan account when you leave your job is certainly tempting. However, cashing out could leave you with a lot less in retirement. You may have to pay taxes and penalties, and you’ll also be losing the tax benefits that come with a retirement plan account.
Benefits of cashing out
Most financial experts advise against cashing out. However, withdrawing your plan balance does give you cash in hand. You’ll have money to take care of current needs.
Things to keep in mind
You may have to pay federal taxes. Before you receive your payout, your employer must withhold 20% of the taxable portion of your distribution for federal income taxes. Depending on your income tax rate, you may owe even more on the taxable amount.
Qualified withdrawals from Roth accounts, including earnings, are tax-free. Only the earnings portion of nonqualified withdrawals from Roth accounts is taxable. Withdrawals from Roth accounts are tax-free if the account was established at least five years before, and if you’re at least 59-1/2 years of age or if withdrawals are made because of disability or death. Withdrawals from your non-Roth balance are generally taxable.
- Penalties may apply. If you’re under age 59-1/2 when you cash out, you may have to pay a 10% early withdrawal penalty on the taxable portion of your distribution. If you’re 55 or older when you leave your job, withdrawals are penalty-free but still taxable. Other exceptions may apply.
- You may be hit with additional taxes. You may owe state and local taxes on the taxable portion of your distribution.
You can reduce what you owe. Instead of cashing out your entire account balance, consider taking a distribution for just what you need. That way, you avoid paying applicable taxes and penalties on the rest of your account. The remaining amount has the opportunity to keep growing tax-deferred if you leave it in the plan or roll it into an IRA or another plan. Roth accounts can be rolled only into Roth IRAs or plans that accept Roth rollovers.
If you take a full distribution and were born before 1936, you may be eligible to use a one-time option known as 10-year forward averaging to reduce the amount of taxes you owe. Check with your financial professional about the specific rules for lump-sum withdrawals.
Spend it or save it?
Measure the tax implications and penalties of staying tax-deferred and cashing out with the Spend it or save it calculator.
Take the next step
Find out how to start the rollover process to an American Funds IRA or how to initiate another transaction.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional or downloaded and should be read carefully before investing.