Ask Me Help Desk - 401K withdrawal

Is it ever a good idea for a 401K, valued at 36000, to be cashed out before retirement? I quit with the above employer over 10 years ago.

I am 47 and both wife and I are working (gross income just over $100K).

The only purpose for me would be to immediately pay off $26000 in loans (2 auto, 2 credit cards) and free up $1000 month to increase my current employers 457 account, my wife's 401K, create a cash reserve, improve credit rating and add to a ROTH IRA.

Ultimate objective is to be virtually debt free from age 48 (March 2009) until retirement. Cashing out would get us there earlier.

I bet the advice you get is pretty universal - do not cash the 401(k) out unless you are absolutely forced to. Remember your 401(k) is intended for retirement, and by cashing it in early you are setting yourelf up for trouble later on. Cashing it out will result in you paying 10% in penalties plus income taxes (both efereal and state, depending where you live), so the $36000 may or may not be adequate to fully pay off the $26K in debt. And while it may seem like a nice quick fix to the problems you mentioned, I have to wonder what's going to keep you from getting right back into debt again? The key is to set yourself on a budget that allows you to pay off the debt and start investing for the future. Also, I certainly wouldn't cash out a 401(k) in order to fund a Roth, 457, or your wife's 401(k) - given the early withdrawal penalty that makes no sense.

As be pointed out, after penalties and taxes you might not have enough to cover the $26K. But you also need to look at the cost of your credit. Especially the auto loans. Are they going to cost you anywhere near what you lose by taking the 401K now? Especially when you factor in loss of income on that investment.

No, its almost never a good idea to tap into your retirement savings.

Even while writing the question, I felt like I knew the answer.
Now, after thinking more about it and reading the replies, I know the answer.
Just the 10% penalty is way more than the potential interest $'s I would be "saving".
So the real answer... be diligent and budget conscious and in 2.5 years they'll be paid off anyway.
It's tempting to succumb to the "instant gratification"... but costly.

Rather than beat a dead horse, I will be one of the very few that will break with traditional wisdom and say "Yes"! There are times when an early withdrawl makes sense. I will give you my situation as a good example.

After 12.5 years of heavy investment participation in my former companys 401(k) plan through Principal Financial, I had been able to accumulate a nice $173,000.00 towards my retirement years. I am 50 now. This balance was two years ago. This same investment is now worth $80,200.00 today. Yes! That's two years of decline. I held on to the belief that the market would soon rebound. Truth be told, this rebound may very well be up to 10 years in the making. Now! My wife and I have decided to sell our home and move to the Denver outlying area. If we get close to our asking price, we will walk away with $105,000.00 on this home sale. We have looked at the tax and penalty consequences of an early withdrawl of my account. With the after tax amount and the profit from our home, we will be in a position to finance about $40,000.00 for 5 years on our new home if we can keep the price under $200,000.00. Some will say, why not finance the remaining $100,000.00 and use the interest as a tax write off? I say what write off? This so called belief that there is benefit in a tax write off (deduction) of the interest is just hog wash. It only amounts to about 12% of the tax paid. That was my wake up. So, my 36% one time hit on my 401(k) withdrawl turns out to be quite a fantastic deal after all. It seems the only ones that recommend retaining the 401(k) and taking a loan against it as the worst case situation or taking on more debt with a second mortgage (home equity loan) are the very ones making a living off keeping this money invested. Yes! Investment advisors, etc..

The best way to make this decision is to get a pad and paper out. Pull the calculator out and figure out the long term effect of borrowing and borrowing and moving debt around from here to there. Then look at the one time hit on the 401(k) withdrawl and the debt paydown. Then look at that blank piece of paper in front of you showing your debt. Ah! What a nice feeling this is. Not only is debt not a concern for me, but I can invest almost anything I make from now until I'm dead. I say that because I'm almost semi retired now and after this move, will be. I won't be paying for a large home loan, a home equity loan, repayment of a 401(k) loan, credit card debt, and on and on. I will just be making money.

Quote:

Originally Posted by skibroken

Rather than beat a dead horse, I will be one of the very few that will break with traditional wisdom and say "Yes"! There are times when an early withdrawl makes sense. I will give you my situation as a good example.

Normally I would remove your post since this thread is 6 months old. However, I decided to tell you that your advice is wrong.

The tax writeoff you disdain allows you to effectively reduce the interest rate cost of the loan. So what you did was wrong on several levels. First you locked in your losses by cashing in the account. What was an $80K loss only on paper is now a real $80K loss. Worse, its not a loss you can use to adjust your taxes. So you start with throwing away $8K in penalties. I suspect that the loss of a tax deduction would more than offset that $8K. In addition, you probably are paying more in tax liability for the additional income. You mentioned 36%. That means that you paid almost $29K in taxes and penalties to avoid how much in interest? And its not a "one-time" hit. This money is not working for you. So you are losing out on the income it could produce.

No, I'm sorry, I doubt if the REAL numbers justify the cash out.

OK.. how about this. Lets say you cash out a 401K with 60k, pay the ten percent and take 30k of it and invest in something that has great tax incentives, like domestic oil exploration or something. You can make the penalties up at the end of the year, write off the investment and have your money in something that could possibly return more than the stinking -7% I've made in mine over the last 15 years.