How 401(k) Withdrawals Can Be a Big Mistakehttp://www.fool.com/retirement/401k/2012/10/10/how-401k-withdrawals-can-be-a-big-mistake.aspx Dan Caplinger
October 10, 2012
Despite having some shortcomings, employer-sponsored 401(k) accounts can be extremely useful in helping you save for retirement. Yet too many people end up taking money they should earmark for their financial future and using it for immediate gratification, leaving themselves that much further behind in building a secure nest egg.
401(k) withdrawals don't have to be a bad thing. But to avoid unfortunate consequences, you have to be smart about it. Below, you'll find several tips on when moving money out of your employer-sponsored retirement account is smart versus when it's a big mistake.
A definite no-no: Blowing it in one fell swoop
But withdrawing your 401(k) money and simply spending it doesn't just deplete your retirement savings; it also exposes you to unnecessary taxes and penalties. Every dollar that you take out of a traditional retirement plan gets added to your taxable income on your tax return and in turn increases your eventual tax liability when you file with the IRS the following April. Even worse, unless you're at least age 59 1/2, you'll end up paying an additional 10% penalty on top of the tax hit from your withdrawal.
A little better: Using money for certain expenses
Even without the penalty, though, using 401(k) assets still forces you to pay income tax on the amount you take out. In addition, once the money's out, you're not allowed to redeposit the money back into your retirement account unless you're eligible as a current employee at a company that offers a 401(k) plan.
The smart choice: Rolling it over
The best way to move money is to do a direct transfer, where your m