Partially cashing out a 401(k) when leaving an employer

When you leave an employer, you normally get to choose to cash out your 401(k) or roll it over into a new account (right?), but are you permitted to pursue a half-and-half approach?

That is, cash out some of it, and roll over the rest into a new 401(k)?

Obviously, this entails tax penalties for early withdrawal and all that, but is it allowed?

IME, every plan will have different rules.

Yes you can.

When leaving your employer, you may take your 401(k) in cash, roll it over to an IRA, or roll it over to another qualified employer plan (if it accepts roll-ins). Your former employer and your former employer’s plan cannot stop you from doing this. Yes, you may take part in cash and roll over the rest.

http://www.bankrate.com/finance/taxes/tax-penalty-for-cashing-out-401k.aspx

And let me warn you of something: If you take control of the money, rather than let it be transferred directly from your former plan to an IRA or a new employer’s plan, 20% of the taxable amount will be withheld for federal taxes (plus whatever state withholding may apply). Many people believe that this withholding covers their tax liability and they will owe nothing more. The actual amount you owe will be calculated when you fill out your state and federal tax returns at the end of the year. Think of the withholding as just a down payment on what you will actually owe.

Yeah, I accidentally did exactly this. It took the IRS two years to catch the error by which time I had both A) Done it two years in a row, and B) Had no money left to pay the back taxes!

Also, there are sometimes different kinds of IRA accounts with different transfer vs withdrawal tax rules. In my case my HR person advised me to first rollover money from one to the other, then withdraw it from there. Otherwise I’d have had to pay taxes on it twice!

Sorry, mis-read the OP. When I left my last job, I tried to move just part of my 401k but found it was all or nothing. Job before that was ok with partial.

Obviously, leaving the money in a 401k or a IRA is the best. However if you really, really want the money now - consider a loan after rolling into the new 401k.

Best approach for the transfer is “trustee to trustee”.

20% (witheld as retainer)
4% (add’l taxes)
10% (prior to age 59½)
34% yikes!

And that isn’t the end of it. The money that you keep will be added to your yearly income when you file taxes at the end of the year, so it may boost you into an income tax bracket that your withholding amount is not prepared for.

The 20% is an amount that is withheld from your pay-out for estimated federal tax, you may pay a much higher rate at the end of the year when you file. Maybe 39%. No taxes are withheld to cover your state taxes because that rate varies widely for various states. Some states do not have income tax, some have sales tax only and some have a combination. So here in Oregon that adds 9.9% state income tax to my tax burden.

And then you may get placed into one of the highest tax brackets due to your new annual income.

I went through a company resale where my bosses were not able to tell me if I was going to be retained into the new company. It was a stipulation of the sale, they were not allowed to tell me. I was young and stupid and was a single father with 2 young boys and a retired mother at home to take care of, so I kept about $40k that I should have just waited and rolled over into the new plan since I was retained through the sale.

Holy shit. The 20% withholding was way too low, no state taxes were held so I had to come up with another $4000 to pay them. On top of that I was now placed in the highest tax bracket and got a letter from my state IRS that since I was now making so much money that I needed to begin paying my taxes quarterly instead of annually.

I learned and recovered but doing this is a very. bad. idea!

Right.
If you withdraw cash before the proper age, kiss off half of it, due to various Federal and State taxes and penalties. ymmv.

Dont do it.

Now, if you take funds from a 401k at a company you no longer work for, the age goes down to 55, rather than 59.5. Little known fact.

More than half if you consider the time value of money.

My oft repeated tale is a small retirement account I ignored for 30 years. It was only $2100 (about enough to cover 20% of my annual expenses back then). Now it is $65,000.

It can be a good idea to transfer the money out of an employer plan and into a low-cost, low-fee IRA plan of your own choosing. Sometimes the employer plans are highly managed and may have high cost funds. The fund manager may take 2-3% per year to manage the fund. If you’re just looking for an invest-and-forget index fund, you may be better off rolling it into a low-cost Vanguard IRA or something with a really low expense ratio.

Just be careful if you ever intend to use the trad –> roth conversion loophole. If it’s a loophole. Maybe it’s an intentional feature.

Just a question for clarification:

If you ***lose your job, ***and cash out your employer-provided 401(k,) are you still subject to penalties? Because you have to roll it over or cash out due to no longer being employed. It doesn’t seem like the same as someone who more “frivolously” makes premature withdrawals.

Yes, unless you are 55.

OK, thanks.

The legislative intent is not to penalize frivolity, but to encourage retirement savings.

In addition, most company plans have a limited number of investment options, while you have a lot more flexibility outside of them.
It is better now than it used to be. My first 401K, from AT&T, had exactly 2 options.

I guess the question has been answered, so hopefully no one minds me piggy backing, but, Is it true you can use your 401k money towards a first home with less tax penalties?

I *think *you can only withdraw prematurely for “hardship.” This doesn’t sound like hardship.