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Lessons from Marco Rubio's 401(k) cashout

Last week Sen. Marco Rubio, R-Florida, made news by cashing out his 401(k) plan account. Rubio explained that he needed the money for several pressing financial needs, including replacing some home appliances, paying his children's college costs and to raise funds for his White House run. He filed a financial disclosure showing he withdrew about $68,000 from an account at a former employer.

Although providing Americans with a lesson on how to approach taking money from a 401(k) plan probably wasn't his motivation, there's definitely something to be learned here. Let's start with some tax consequences.

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Withdrawals from 401(k) plans are subject to automatic 20 percent tax withholding. So, Rubio would have received a distribution less this withholding, for a net amount of about $54,000. Assuming his income tax bracket is higher than 20 percent, he'll owe more taxes when he files his 2015 tax return. Also, because Rubio isn't yet 59 1/2, he'll also have to pay an additional 10 percent early withdrawal tax, which will be about $6,800.

Bottom line: After income taxes and penalties, Rubio will have a little more than $40,000 of the $68,000 left to use.

I'm not saying what Rubio did was a financial mistake. I'm sure he thought about it carefully and was likely well advised. Also, given that his well-publicized action makes him look like just another member of the middle class experiencing the same day-to-day financial struggles as any growing family, I'd say more than just financial matters were involved in his decision. It was good PR.

That said, you may also be considering cashing out a former employer's 401(k) plan to pay for some pressing financial matters because you have no other practical alternative (emergency funds, home equity loan, etc.). But before you do it how Rubio did, consider first rolling over your 401(k) plan account to an IRA, and then taking your withdrawal from the IRA. Here's why:

First, three types of IRA withdrawals may be exempt from the 10 percent early withdrawal penalty tax, including withdrawals for qualified higher education expenses, for qualified first-time home buyers (up to $10,000) and for paying health insurance premiums while unemployed. Rubio could have considered this for the withdrawal for his children's college costs.

Second, unlike withdrawals from a 401(k) plan, IRA withdrawals aren't subject to an automatic 20 percent tax withholding. If your income puts you in a lower tax bracket, taking a withdrawal from a 401(k) plan will result in overpaying your tax liability, and you'll have to wait until you file your 2015 tax return to get your money back.

But if you still want taxes withheld from the IRA withdrawal (which I typically suggest), you can direct the IRA custodian to do so, and you can specify the percentage or dollar amount you want withheld.