Advice on tax
Cashing out a Roth 401(k) can have significant tax implications, particularly if you're considering reinvesting the amount you set aside for taxes. Here’s a breakdown of the relevant rules and consequences:
## Tax Implications of Cashing Out a Roth 401(k)
1. **Contributions vs. Earnings**:
- You can withdraw your contributions to a Roth 401(k) tax-free and penalty-free at any time since those contributions were made with after-tax dollars[1][3]. However, if you withdraw earnings (the growth or dividends from your investments), you will owe ordinary income tax on those amounts if you are under age 59½ and have not met the five-year holding requirement[2][4].
2. **Early Withdrawal Penalties**:
- If you withdraw earnings before age 59½, you will incur a **10% early withdrawal penalty** in addition to the income tax owed on those earnings[2][3]. This means that even if you set aside funds to cover your expected tax liability, the penalty would still apply to the earnings portion of your withdrawal.
3. **Reinvesting Withdrawn Amounts**:
- If you cash out your Roth 401(k) and reinvest the amount set aside for taxes, you will still owe taxes on any earnings withdrawn from the account. The act of reinvesting does not negate the tax liability incurred from the withdrawal itself[1][3].
4. **Qualified Withdrawals**:
- To avoid taxes and penalties altogether, you must wait until you are at least 59½ years old and have held the account for at least five years. At that point, both contributions and earnings can be withdrawn without any tax consequences[2][4].
## Summary
In summary, if you cash out your Roth 401(k) and withdraw earnings before meeting the age and holding period requirements, you will owe taxes on those earnings along with a 10% penalty. Setting aside funds to cover these taxes does not exempt you from these obligations. To fully benefit from a Roth 401(k), it is advisable to adhere to the withdrawal rules regarding age and account duration.
Citations:
[1] https://www.bankrate.com/retirement/how-to-withdraw-from-401k-early/
[2] https://smartasset.com/retirement/understanding-the-roth-401k-withdrawal-rules
[3] https://www.investopedia.com/ask/answers/102714/how-roth-401k-taxed.asp
[4] https://www.nerdwallet.com/article/taxes/401k-taxes
[5] https://www.floridaelder.com/little-known-tax-roth-401k-distributions/
[6] https://www.schwab.com/learn/story/should-you-consider-roth-401k
[8] https://www.irs.gov/retirement-plans/roth-acct-in-your-retirement-plan