401k Distribution Options
Question: We are about to lay off a significant percentage of our hourly workforce and I want to make sure that they understand what to do with their 401k funds. What are their options?
Answer: If an employee leaves a job, they have three choices when it comes to their 401k plan. Here they are, with the pros and cons of each.
Leave the money in the plan, if your employer allows you to.
Pro:
You keep your money invested in the 401k.
Con:
You will not be able to make additional contributions to your account and you will not receive matching funds from your employer.
You have limited fund choices within the 401k plan.
Roll your 401k into an IRA.
Pro:
You may have more and better investment choices in an IRA and therefore gain greater diversification
You can avoid taxes and penalties
You can continue to defer taxes on your retirement savings, which helps you accumulate more money because you are not paying tax on your account's earnings every year.
You are able to sever ties with your former employer
Con:
You may pay higher fees on your investments in an IRA than you would if you left your money in your 401k. This may not be the case for everyone, as investment expenses vary widely.
Take a taxable distribution.
Pro:
There really is no good reason to do this, and you should avoid cashing out your retirement account whenever possible. Even if you have a small amount in your 401k, that money has the potential to grow significantly over time with the benefits of tax-deferral.
Con:
You may owe a 10 percent penalty tax if you are under age 59 ½.
You will face mandatory federal income tax withholding of 20 percent, which may or may not be enough to cover your income tax liability, so you may owe even more money come tax time.
You will take a big step backwards in your progress towards saving for a comfortable retirement.
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