Cashing Out Retirement

Today TaxMama hears from Jessie in California, who’s broke. “ I am 22 years old and unemployed. I recently hit a financial snag and am really considering cashing out my 401(k) plans. In total it would amount to $4,995.85. Because of state and federal taxes as well as the fee for cashing out early, how much of that money would I actually see once its deposited into my account?”

TaxMama answers a question on Tax

Dear Jessie,

Surely, you can find some work, however beneath you, to cover your fixed living expenses? I cannot imagine being 22, healthy, and smart and not finding anything at all – even if it’s as onerous as phone soliciting or washing dishes. I know the market’s rough out there. But if you want to work, there is always something to find. Just knock on doors at local businesses. You’d be surprised. Sometimes, you’ve knocked at exactly the right moment!

Of course, if you’re collecting unemployment, there’s no incentive to look for menial work. Unemployment pays better.

So, how much will drawing the 401(k) prematurely cost you? I don’t know. That will depend on your tax bracket this year. However, this I know for sure. Your early withdrawal penalties will be 12.5% (IRS 10% – CA 2.5%) – that’s about $625.00 (rounded) .

Your income taxes on the funds will be higher than you think for IRS. You see, the unemployment you collect is taxable on your federal tax return. It’s not taxable for California.

But let’s say you are only in a 10% bracket for IRS. You probably won’t owe any state taxes at that level. So your income tax would be an additional $500.00. Expect to lose about $1125.00 + whatever fees your investment company charges. If you’re in higher tax bracket, the taxes could run as high as 30% – so you would lose over 42% of your money – nearly half of it! Is it still worth it?

If not, consider using a 0% credit card – if your credit is still good. They will charge you about 3% as a cash advance fee. But that’s still far less than 25% – 42%, don’t you think? Check with your own credit card company to see if they can offer you a cash advance or balance transfer at 0%. If not, visit TaxMama’s Credit Card Center. http://www.cardoffers.com/partners/links/cpa/all.asp?tempid=339850
Use the search tool at the bottom of the page to search for cards with 0% interest.

Besides losing 25% of your savings, if you can somehow manage to leave your retirement savings alone, they will continue to grow, in the long run. If you start making a habit of tapping into retirement funds every time life hits a snag, you’ll never have anything left when you retire. You’re young. Find work. Good luck!

And remember, you can find answers to all kinds of questions about drawing on retirement funds and other tax issues, free. Where? Where else? At TaxMama.com.

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