Think twice before you cash out your 401k!

A cash out 401k can cost you a lot of money now, and a lot of money down the road.

If you are leaving a job and have a 401k just hanging around, then you have 4 options:

• Leave it in your former 401k plan.
• Roll it to a new employer's 401k plan.
• Roll it to an IRA.
• Cash out 401k and pay the penalties

Most financial experts will tell you the best option here is to rollover instead of doing a cash out 401k (Click here for an article about how to rollover your 401k instead of a cash out 401k). Although, everyone's situation is different and a cash out 401k may be right for you. Please consult your accountant before making a decision.

Cash Out 401k

During tough times, it may be tempting to cash out 401k money. But cashing out can be more expensive than even using credit cards to get by. Cash out 401k should almost always be a last resort. A cash out 401k will cost you 30-40pct tax now AND then a 10pct penalty (Ouch!). Let alone, what you do a cash out 401k could be possibly 5x-10x that amount in lost retirement money from one cash out 401k.

If you cash out 401k, you must pay federal and state tax. You'll also owe a 10 percent early withdrawal penalty but only if you are under 55 when you leave your job.

Let's say you are 40 and have $50,000 and you are going to cash out 401k. A withdrawal like that would guarantee you in the 27% federal tax bracket ($13,500 in taxes) and possibly higher. Then a 10% penalty ($5,000) from the cash out 401k and you will be left with around 60% of your cash out IRA ( Around $30,000). State income tax will possibly cost another $2,000-$3,000.

If you cash out 401k then you are restarting the clock on your retirement date. You will miss out on the growth your money has had to date and future growth.

Laid-off or no current income

If you are laid off, then you may feel forced to cash out 401k to pay the bills. It may be more cost-effective to attempt to borrow instead. Maybe a refinance or home-equity loan to get by until things improve instead of cash out 401k.

Try here to shop around for a home-equity loan

If you have to cash out 401k, a possible better route would be to roll it into an IRA and just take what is needed, to learn how to rollover, try this link.

Consider taking a loan against your retirement equity instead of cash out 401k.

If your 401k plan allows loans, you can borrow up to 50% of your account balance or $50,000, whichever is less instead of cash out 401k. You have a maximum of five years to repay the loan from yourself, unless you are borrowing for a first home, which allows a longer payback for the cash out 401k loan. This is possibly a much better option that just a cash out 401k. What happens if you don't repay your cash out 401k loan? Well, then you owe the penalties and taxes, just like if you were to just cash out 401k in the first place. Of course, before considering a cash out 401k loan, you should consult your accountant.