Taking 401(k) Distributions

A recent study [by Hewitt Associates] reveals that 68% [!] of those who changed jobs in 1999 kept retirement plan distributions from the old job instead of transferring that cash to an IRA or a new employer's plan. (*)

This is money for your retirement. A disturbingly large number of people view such distributions as a "windfall" or "found money" and use it to buy a car or go on vacation. There is only thing to do with this money - roll it over into another tax-deferred retirement savings mechanism!

One objection which is often raised when I say this is that an employee who is laid off may need this money for day-to-day bills. Well, my first thought is that if you don't have an emergency fund set up, you shouldn't be contributing to a 401(k) in the first place. But there's no use crying over spilt beer, so let's just look at what the right thing to do is you do happen to find yourself in this unfortunate situation.

You should still roll it over into an IRA. Here's why... If you take a taxable distribution, you pay federal income tax, state income tax and the penalty tax up front and on the entire amount. If you instead roll it over and withdraw funds from the IRA only as needed, you pay the taxes only on what you end up actually needing, which could save you a substantial amount. Furthermore, you pay these taxes at the end of the year when you file your tax return. If you are in a situation dire enough that you are tapping into your retirement funds, this is not an insignificant consideration.

(*) Registration may be required. It's free, and The Motley Fool has a lot of great financial information. You can use BugMeNot to go ahead and browse their site.