A 401(k) is a retirement savings option available to many workers in the United States through their employers. It allows employees to contribute a percentage of their income to a designated account before taxes are deducted. In some cases, employers may match a portion of the employee’s contributions, sometimes up to 100%. Generally, you can’t withdraw funds from a 401(k) until you’re of the age 59 ½. But in certain circumstances, early access is allowed.
Read on to learn how you can cash out a 401(k) in 3 easy steps.
Are you eligible to withdraw your 401(k)?
When it comes to withdrawing from a 401(k) retirement account, you need to follow specific guidelines. Generally, you are not allowed to take money out of your 401(k) until you reach the age of 59 ½ without incurring penalties. However, circumstances exist where you may be eligible for a hardship withdrawal.
A hardship withdrawal is when you take money out of your 401(k) because of an immediate and heavy financial need. Examples of such needs could include medical expenses, preventing eviction or foreclosure, or paying for funeral expenses. Note that a hardship withdrawal is an authorized withdrawal, which means the Internal Revenue Service (IRS) can waive penalties for taking the money out early. But you still have tax responsibilities and will likely have to pay income taxes on the amount withdrawn.
Be sure to verify if you’re allowed to make a hardship withdrawal before tapping into your retirement savings. The IRS has specific rules governing these withdrawals, and your employer or plan sponsor may also have additional guidelines or restrictions in place.
Should you cash out your 401(k)?
Deciding whether to cash out your 401(k) is a significant financial decision that should be carefully considered. It’s important to weigh the advantages and disadvantages before making a choice.
Advantages of cashing out
Immediate access to funds: Cashing out your 401(k) provides you with immediate access to the funds, which can be beneficial in times of financial need or emergencies.
Paying off debt: If you have high-interest debt, such as credit card balances or personal loans, using your 401(k) funds to pay off that debt could potentially save you money on interest payments over time.
Flexibility and control: By cashing out your 401(k), you gain more control over how you use the funds. You can invest in other opportunities or use the money for personal needs or desires without restrictions.
Disadvantages of cashing out
Taxes and penalties: Cashing out your 401(k) before reaching the age of 59 ½ typically incurs a 10% early withdrawal penalty imposed by the IRS. The withdrawn amount is subject to income tax, potentially pushing you into a higher tax bracket and increasing your overall tax liability.
Lost retirement savings: By cashing out your 401(k), you deplete your retirement savings. This can have long-term consequences, as you lose out on potential growth and the power of compounding that could significantly impact your financial security in retirement.
Missed employer contributions: If your employer matches your contributions to the 401(k), cashing out could mean forfeiting the future contributions they would have made on your behalf, essentially leaving money on the table.
Possible opportunity costs: The funds you withdraw from your 401(k) could have been invested in other retirement accounts or financial instruments that offer potential growth and tax advantages over time.
Cashing out your 401(k) should be viewed as a last resort. It’s usually advisable to explore other options, such as taking out a loan, finding alternative sources of income, or considering a rollover to an IRA that allows you to maintain the tax advantages and preserve your retirement savings.
How to cash out 401(k) in 3 easy steps
Before proceeding with a 401(k) withdrawal, it’s important to follow these three steps.
1. Determine your eligibility
The IRS generally allows individuals to make withdrawals from their 401(k) plans once they reach the age of 59 ½. Different plans may have varying rules and regulations regarding withdrawal eligibility, so you’ll definitely want to familiarize yourself with your specific plan’s guidelines.
2. Prepare documents to show proof
Depending on the reason for your withdrawal, you may need to gather and provide supporting documentation. If you’re seeking a hardship withdrawal, you might be required to provide proof of hardship or disability.
3. Contact your 401(k) plan administrator to request a withdrawal
Your 401(k) plan administrator plays a key role in managing your retirement account. They are responsible for overseeing the withdrawal process and can provide you with the necessary guidance and information as well as initiate the process. If you have questions about the specific steps, paperwork, or additional requirements for completing a withdrawal from your 401(k), contacting your plan administrator is the recommended course of action.
How can you withdraw your 401(k) without paying penalties?
While there are scenarios where you can withdraw from your 401(k) without incurring penalties, it’s important to note that you may still be subject to taxes on the withdrawn amount. Let’s explore some situations where penalty-free withdrawals may be allowed.
1. Higher education expenses
If you incur higher education expenses, such as tuition, fees, or books, you may be able to withdraw funds from your 401(k) penalty-free. However, you will still have to pay income tax on the withdrawn amount.
2. Unreimbursed medical bills
In certain cases, if you have unreimbursed medical expenses that exceed a certain percentage of your adjusted gross income (AGI), you may be eligible to make penalty-free withdrawals from your 401(k). The specific threshold for qualifying medical expenses can vary, but generally, it must exceed 10% of your AGI. Again, income tax will still apply to the withdrawn amount.
3. Health insurance premiums
If you’re unemployed and receive federal or state healthcare subsidies under the Affordable Care Act, you may be able to withdraw from your 401(k) penalty-free to cover health insurance premiums. Income tax will still be applicable.
If you become permanently disabled and are unable to work, you may be exempt from the early withdrawal penalty when taking distributions from your 401(k). However, the withdrawn amount will still be subject to income tax.
In the unfortunate event of the account holder’s death, beneficiaries can typically withdraw from the 401(k) without penalty. However, they’ll need to pay income tax on the distributed amount.
What are the tax implications of cashing out your 401(k)?
Cashing out before the age of 59 ½
You’ll be subject to a 10% early withdrawal penalty imposed by IRS if you cash out before the required age. This penalty is in addition to the income tax you will owe on the amount you withdraw.
When you withdraw funds from your 401(k) account, the distribution is treated as ordinary income for tax purposes. This means that the withdrawn amount will be added to your taxable income for the year, potentially pushing you into a higher tax bracket and increasing your overall tax liability.
It’s important to note that your 401(k) distributions, whether taken as a lump sum or periodic payments, are generally taxable unless they meet specific criteria for exceptions or exclusions, such as qualifying Roth IRA contributions or designated Roth accounts.
3 alternative options to consider
To minimize the tax impact, it’s a good idea to explore other options before resorting to cashing out your 401(k) prematurely.
1. Add more sources of income
One option is to take up side hustles, like selling items online or finding gigs related to your field. These side hustles can provide extra cash without the tax implications and penalties associated with early 401(k) withdrawals.
2. Maximize promotional credit card offers
Another option is using promotional credit card offers. Some credit cards offer zero-interest periods for balance transfers or purchases. By taking advantage of these offers responsibly, you can temporarily free up some cash and avoid paying interest on certain expenses.
3. Apply for a low-interest loan
Consider applying for a low-interest loan. These loans typically have favorable interest rates compared to other forms of borrowing, such as credit cards or personal loans. You’ll want to exercise caution when taking on debt and ensure that you can comfortably repay the loan within the agreed-upon terms to avoid further financial strain.
MoneyLion helps you find personal loan offers* based on the background and info you provide. You can get matched with offers for up to $50,000 from top providers. You can compare rates, terms, and fees from different lenders and choose the best offer for you.
In a Nutshell: Think Twice Before Cashing Out Your 401(k)
It’s typically not possible to take withdrawals from your 401(k) without facing penalties until you reach the age of 59 ½. However, there may be instances where you feel you need to access those funds. Consider all the implications, both in terms of taxes and long-term financial well-being. Remember to explore other options before jumping into a decision and seek advice from financial professionals. By making an informed choice, you can protect your retirement savings while addressing your immediate financial needs.
How long does it take to cash out a 401(k)?
The timeframe for cashing out a 401(k) varies depending on the specific plan and the administrative processes involved. Generally, it may take several weeks to a couple of months to complete the withdrawal and receive the funds.
How much can I withdraw from my 401(k)?
The amount you can withdraw from your 401(k) depends on various factors, including your age, the plan rules, and applicable tax considerations. Typically, you can withdraw the vested balance in your account but keep in mind that early withdrawals before the age of 59 ½ may incur penalties and income tax.
Can I cash out my entire 401(k) at once?
In most cases, you have the option to cash out your entire 401(k) balance at once. But it’s important to consider the tax implications and potential penalties associated with early withdrawals. It’s recommended to explore other options, such as rollovers to IRAs or leaving the funds invested for retirement, before cashing out the entire amount.