Retirement Money and Early Withdrawals

Hopefully, many of you have accumulated money in your pension and/or 401(k) plans. What happens to this money if/when you leave the company? If you are laid off, it will be tempting to cash out. However, it is important to understand that there will be very negative consequences for doing so.


The key consideration is that this money is supposed to be for your retirement. By taking the money out of a retirement account, you are depleting your nest egg. In addition, there are very negative tax consequences for cashing out prior to the age of 59 ½. First, the money that you take will be considered taxable income. That doesn’t necessarily seem so bad; however, this additional lump sum of income within one tax year could push you into a higher tax bracket. In addition, the additional income could cause you to lose certain tax credits that you would otherwise qualify for, such as earned income credit, child tax credit, etc. Making a withdrawal will also disqualify you from receiving the saver’s credit. In addition, the IRS will assess a 10% penalty for making an early withdrawal from a retirement plan. The overall impact of this can be devastating. Many people assume that they will not have a problem at tax time, because they asked their employer to take out the taxes at the time that they made the withdrawal. However, if you make that selection, your employer will only take 20%, while the impact on your tax return can be substantially higher than that. For example, I completed a tax return for a client who made a $1200 withdrawal from her 401(k) account. After assessing the impact due to additional income tax, lost credits, and penalties, the client incurred an additional $800 in taxes! Therefore, 67% of the withdrawal went to the IRS!