Dear Dr. Per Cap:

I switched jobs and want to cash out my 401k from my previous job at the Bureau of Indian Affairs.  I’ve been told this is a bad idea but my wife and I could really use the extra money, especially with the holidays coming up.  What should I do?

Signed, #1 Sooner Fan

Dear Sooner Fan

An early distribution from an employer sponsored retirement plan, i.e. your 401k, is a bad idea.  Here’s why:

1.  It’s called a retirement plan for a reason.  The money you contributed or deferred to the plan along with any additional contributions that your employer matched is your nest egg for the future – long term retirement savings not a cash cow for holiday gifts or vacations.  And it’s certainly not free money or some kind of a bonus.  You worked hard for all those dollars so hang on to them!
2. You’ll owe a penalty on the early withdrawal.  Unless you are at least age 59½ you’ll have to pay 10% of your total distribution to the IRS at tax time.  Moreover, you’ll also owe tax on the original amount of your 401k deferrals along with any earnings.  Remember those contributions were tax deferred meaning they lowered your taxable income during the years you were working at the BIA.
3. You’ll owe a penalty on the early withdrawal.  No, this isn’t a typo.  10% might not seem like a lot but it is, especially if the balance in your account is substantial.  It’s like paying a $10 fee to cash a $100 check – ouch!

Ok, those are the reasons not to make an early withdrawal but I understand how tempting it is to pull that money out.  Another temptation to avoid is to borrow from your 401k.  My advice is to consider that money locked away until you are ready to retire – out of sight, out of mind.  In the meantime here are some better options than an early distribution.

1. Transfer or roll over your 401k to your new employer’s 401k plan if possible.  Some employers will allow this but some won’t so check with your new employer first.
2. An indirect roll over of your 401k into a self-directed IRA you manage yourself.  The way this works is you’ll receive a check for the balance of your 401k.  You’ll then have 60 days to deposit the funds in a new retirement account of your choice.  Just make sure you do this within the 60 day timeframe.  If not the IRS will consider it an early distribution and hit you with the tax and penalty described above.
3. Don’t do anything.  As a former federal employee you have the option of keeping your 401k in the Thrift Savings Plan (TSP), a defined contribution plan for U.S. civil service employees and retirees, as well as members of the uniformed services.  Not to sound like a pitch man but the TSP is one of the best employer sponsored retirement plans with extremely low fees.  You can hold onto your account, periodically review your holdings, and when you reach retirement age begin making penalty free distributions.

I think the third option is your best move.  Keep an eye on the long term, good luck, and Go OU!Ask Dr. Per Cap is a program funded by First Nations Development Institute with assistance from the FINRA Investor Education Foundation. For more information, visit www.firstnations.org. To send a question to Dr. Per Cap, email askdrpercap@firstnations.org.