Rollover into a Roth or Cash out?

[misle]

I received paperwork today from my old job giving me to option to rollover my retirement benefit or cash it out.

The amount is around $5,600. If I cash it out, I'll have to pay 20% to taxes, leaving me with about $4,500.

Edit:
Alright, IRA it is. Now, um, how do I do that?

 

[Night201]

It's a 401(K) we're talking about here?

If you're making 50k, you should be able to pay off $5k pretty quickly.

Does your credit card have more than a 20% interest rate? If not, then why would you even consider losing approx. 20% to pay off something that is only maybe 15%? Even so, if it was 23% I still wouldn't cash out my 401(k) for that. I also believe that you have to pay it back and also will probably get hit with an additional 10% withdrawl fee, so you're losing really like 30-40% probably. Not to mention that you won't be getting any interest on it.

How much do you have saved up for your house? Is it in your savings or checking account? If you have more than 5k, then take that money and pay of your credit cards. Even if it is in savings, you're probably making <6% on interest - so take that money. Then start to begin saving again for your house.

 

[Night201]

Answer these for me:

What state do you live in?
Are you living at home or renting? If so, how much do you pay in rent?
Do you have a car now? year/make/mode?
What is the interest rate on your student loan? How much do you owe?
What kind of car are you saving for?

The answer here is to roll over into a Roth IRA, but I want to help guide you a little more here...

 

[BoldAsLove]

ROTH FTW

 

[EagleKeeper]

You will lose more that 20% to taxes.

That is what will be confiscated up front. (Penaly for taking the cash)
then you will still ahve to pay regular tax on the amount at the end of the year.

Given your income bracket, you could lose over $2500 of the distribution when all is said and done.

 

[FoBoT]

rollover to a roth, no brainer

 

[kranky]

That $5600, growing at an average of 8% per year tax-free, will be worth $107,012 when you are 65. If you cash out, that's what it's really costing you.

Withdrawing 401k money early is one of the most common and most damaging mistakes people make. They don't think it's a lot of money, but when it grows for 30+ years it turns into a lot.

Roll it into an IRA, and buckle down to pay off those CC bills, and keep saving for retirement. At your age, you need to keep that money going in so it can grow for many years before you need it.

 

[mrchan]

Originally posted by: EagleKeeper
You will lose more that 20% to taxes.

That is what will be confiscated up front. (Penaly for taking the cash)
then you will still ahve to pay regular tax on the amount at the end of the year.

Given your income bracket, you could lose over $2500 of the distribution when all is said and done.

Yep. There is only one logical answer here......


Cash out and buy 12,500 chicken nuggets from Wendy's.

 

[JS80]

got a late start huh? late start so you definitely should roll it over. i definitely don't want to be supporting you when you retire.

 

[misle]

Originally posted by: EagleKeeper
You will lose more that 20% to taxes.

That is what will be confiscated up front. (Penaly for taking the cash)
then you will still ahve to pay regular tax on the amount at the end of the year.

Given your income bracket, you could lose over $2500 of the distribution when all is said and done.

Oh, didn't realize I would have to pay income taxes on it as well. Okay, Roth it is. Now, can someone tell me the best way to do an IRA? Should I find a local financial advisor or just get on Schwab.com?

 

[BlackOmen]

Note that if you roll over a 401k, you are rolling over into a traditional ira. Traditional IRA's are tax compatible with 401k plans because they are both tax deferred plans (ie 401k contributions are before tax contributions). Roth IRA's, OTOH, are made with after tax contributions. You also cannot do a direct 401k to Roth IRA conversion. You would need to roll your 401k account into a traditional IRA. Then you need to meet the income requirements of a Roth to convert the traditional IRA into a Roth IRA.

Since you made your 401k contributions with pre-tax money, you will then owe income taxes for any funds converted (since Roth;s are after tax money). Confusing? You bet it is. You not only need to find a good broker for getting into a good IRA, but you should also consult a CPA about tax implications.

Paging CPA.

 

[CPA]

Black Omen is correct - you cannot directly rollover a 401K into a Roth IRA. You must first roll over to a Traditional IRA, then roll over to a Roth.

Also, you MUST have the 401K trustee make the check out to the to the IRA Custodian. Usually, the trustee will have some paperwork that will ease the transfer. You will have to find a bank or finance company that will set up an IRA for you. Most banks have financial centers that will easily do this for you. If the trustee makes the check out to you, you are screwed. You will be hit with the 20% tax. So do this right.

edit: One other thing - while I realize that you have chosen to do go the "Direct Rollover" route, if you would have cashed out you would have been hit by 20% in taxes, plus 10% Early Distribution penalty. Just a reminder.

 

[bennylong]

Cashing out of your 401k is for idiot. Don't make my rich ass support your poor ass when you're 70 years old, unemployed, without any savings.

 

[Nerva]

rollover, dont cash out.

 

[thomsbrain]

blackomen and CPA have this covered, i think.

BTW, this was a really good question and i bet a lot of people make mistakes (intentional or otherwise) doing this. sometimes i think questions like this should be stickied in a special "Life FAQ" forum.

 

[misle]

Originally posted by: CPA
Black Omen is correct - you cannot directly rollover a 401K into a Roth IRA. You must first roll over to a Traditional IRA, then roll over to a Roth.

Also, you MUST have the 401K trustee make the check out to the to the IRA Custodian. Usually, the trustee will have some paperwork that will ease the transfer. You will have to find a bank or finance company that will set up an IRA for you. Most banks have financial centers that will easily do this for you. If the trustee makes the check out to you, you are screwed. You will be hit with the 20% tax. So do this right.

edit: One other thing - while I realize that you have chosen to do go the "Direct Rollover" route, if you would have cashed out you would have been hit by 20% in taxes, plus 10% Early Distribution penalty. Just a reminder.

Thanks a bunch for the information.

Just to clarify, this is not a 401(k) account. It is from the University of Missouri and they have their own retirement system. I did not have to pay anything into the system to get this retirement benefit. I do not know what kind of account it is.

I did receive a bunch of paperwork from them detailing how I could move the money into an IRA account. I have not read through it yet and I do not have it with me.

One more question:
What's the difference between an IRA and a Roth IRA?

 

[BlackOmen]

Originally posted by: misle
[One more question:
What's the difference between an IRA and a Roth IRA?

Traditional IRA: Contributions are made pre-tax and earnings are tax deferred. Translation: contributions to a traditional IRA can be deducted on your income taxes. You do not pay taxes on these funds until you take a distribution. The idea being that when you are retired, you are in a lower tax bracket.

Roth IRA: Contributions are made after-tax (money you have already paid income taxes on). Advantage: With a Roth IRA, any earnings are never taxed. That's right, never. You also can take a distribution of principal (contributions you made) at any time without penalty or taxes. You may only take a distribution of earnings once you are 59-1/2, or else you pay penalties. You must meet certain income requirements to be able to contribute to a Roth.

A lot of people on ATOT answer Roth IRA no matter what the question, however, I suggest you meet with a financial consultant (a certified FC, not an ATOT armchair investor) to discuss retirement planning, and also talk to a tax professional to discuss tax implications of a Traditional IRA vs Roth. A good FC and tax professional will look at *YOUR* circumstances and make appropriate suggestions. You may find that Roth always isn't the right answer.........

On edit: so what's the difference between Roth and Traditional IRA's in a nutshell: how contributions and earnings are taxed. Both plans will have equal earnings potential when equally invested.

Also on edit: so you are saying that this plan was entirely funded by your employer? If so, that sounds similar to a SEP IRA (except it isn't in this case). If you provide more details, I can provide more insight. Do you want to take this discussion to PM?

 

[alrocky]

There is a traditonal IRA to ROTH IRA conversion calculator on Morningstar.com's website.

$ DUE -- Tax rate

$ 560 -- 10%
$ 840 -- 15%
$1400 -- 25%
$1568 -- 28%
$1848 -- 33%
$1960 -- 35%

Deciding between a traditional IRA and a ROTH IRA is premature since you'll need to roll your account over to a tradtional IRA first anyway. The next step is where to move your money - a brokerage company or a mutual fund company? Likewise there is no need yet to pay anyone to discuss your investments or retirement options. Suggest you read as much info as possible including visiting and posting questions on the Morningstar.com forums. If you eventually decide on mutual funds (stay away from load funds), I'd first look at Fidelity, Vanguard, and T. Rowe Price.