Rising gas and food prices, the disappearance of home equity, downsizing by large and small employers and a credit crunch are a perfect storm for cash-strapped investors. Many are tempted to tap into low-hanging fruit: their 401(k) and 403(b) plans.
Is this a good idea?
Other than as a last resort, this answer is "no."
Even in good times, the number of employees who cash out of their retirement plans is alarming. More than 45% of departing employees cash out of their 401(k) plans.
The consequences of doing so are draconian.
First, your employer will withhold 20% of the value of your 401(k) plan for taxes and the amount you receive will be taxed at your ordinary income tax rate (both federal and state).
Second, if you are less than 59 1/2 years of age, you will get slammed with an additional 10% penalty.
This double whammy can sharply reduce your net proceeds. Someone in the 25% bracket with $100,000 in her 401(k) can end up with only $53,000, assuming the distribution bumps her federal tax rate to 28% and that she has to pay a 9% state tax as well.
Avoid cashing out of your 401(k) or 403(b) plan if you possibly can. It can be a very expensive way to get cash.
Dan Solin is the author of The Smartest Investment Book You'll Ever Read (Perigee Books, 2006) and The Smartest 401(k) Book You'll Ever Read (Perigee Books, 2008).