Tax consequences of liquidating a 401k

A Roth IRA offers investors a unique tool for accessing money in a pinch.

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But if it’s an extremely good plan, and better than the one at your new workplace (or there isn’t one at your new workplace), leaving the money behind may be the best move.

Remember that early withdrawal penalty we mentioned above? If you ask your retirement-fund provider to liquidate your account and send you the proceeds, you will have to pay that fee to the Internal Revenue Service (assuming you’re under 59½).

With a Roth IRA, you will only be hit with the 10% early withdrawal penalty—and owe taxes on—your earnings (not your contributions).

So if you had $20,000 in contributions and took out $25,000, you would owe on the $5,000, not the whole amount.

However, a Roth IRA (see below) offers special opportunities to escape taxes and penalties that aren’t available when you withdraw funds from a Traditional IRA.

Knowing all this, let’s look at the pros and cons of taking funds from your Roth—beyond staying out of the clutches of a bank or other lender.

The issue is, when can you withdraw earnings without paying the 10% early withdrawal penalty mandated by the IRS? All the same, the benefit of being able to withdraw your contributions without penalties or tax repercussions is a great benefit provided only to Roth IRA investors.

The cons of withdrawing money are common to all retirement accounts, but with different wrinkles depending on the laws and regulations that govern them.

The reason: You have already paid taxes on the money you deposited.

Roth IRAs take after-tax contributions (you didn’t get a tax deduction on the money).

A word about “contributions”: This is the term for the money you deposited into your Roth account.

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