A 401(k) plan allows you to put a certain amount of your salary into a retirement account in which your investment gains are tax-free until you start withdrawing from it. You also get to earn free income when your employer matches the amount of money you put into your retirement plan, up to a certain limit.
However, when you need money due to an unexpected large expense or an emergency, you might wonder – can I cash out my 401(k)? In this article, we’ll look at the eligibility, consequences and the process to cash out your 401(k) early.
Eligibility to cash out your 401(k)
You need to meet certain criteria before you can cash out your 401(k). Have a look at these prerequisites to avoid making costly mistakes.
- If you’re still working for the employer that sponsors your 401(k) plan, you are not eligible to cash in your plan and savings. However, you can check whether your plan allows you to take a 401(k) loan or hardship withdrawals to get you out of the situation you are in.
- If you’re no longer employed with the company that sponsored your 401(k) plan, you can access the funds. You can either consider to cash out your 401(k) or roll over the balance into an IRA or a private self-directed 401 k plan.
- If you wish to cash out all or part of a 401(k) fund without being penalized, then you need to be either:
-> of age 59½ or above or
-> Disabled, or
-> Undergoing some sort of financial “hardship”(if your plan allows)
Consequences of cashing out a 401(k) or 401(k) early withdrawal
If you choose to withdraw funds early, you should prepare yourself for these consequences:
- A 20% of a 401(k) early withdrawal will be withheld for taxes.
If you withdraw $10,000 from your 401(k) at age 45, you may get only about $8,000. You might get this money back as a tax refund if the withholding exceeds your actual tax liability.
- You’ll be charged a 401(k) early withdrawal penalty of 10% if you withdraw before age 59½.
This means you are giving away an additional $1,000 of that $10,000 withdrawal to the government. After taxes and penalty, you could be taking home just $7,000 from your original amount of $10,000.
- You’ll have less money for your future.
Cashing out 401(k) early means you’ll have less money to use when you retire. This can severely disrupt your entire retirement plan.
- You’ll receive no credit protection.
Funds in 401(k) plans are protected. In case of bankruptcy, your creditors cannot seize your funds. When you withdraw money from your 401(k), you lose this protection, which may make you vulnerable to hidden expenses in the long run.
Are you still contemplating taking a 401(k) early withdrawal or cashing out a 401(k)?
After knowing the consequences of early withdrawal of funds from your 410(k), if you are still considering cashing it out, then do the following:
- See if you are eligible for a hardship withdrawal
- Check whether you qualify for an exception to the 10% tax penalty
- Consider converting your 401(k) to an IRA
- Take only what is required from your 401(k)
How to cash out 401(k)
Follow these three steps to withdraw money early from your 401(k):
- Check with the HR department to find out whether you can withdraw funds early. If yes, then find out whether you are eligible for it.
- Get in touch with your 401(k) plan provider. Ask for information, and submit the required paperwork to cash out your plan.
- Obtain the required signatures from your HR representatives or plan administrators at your former employer as an acknowledgement that you have filed the documentation to execute the process of cashing out your 401(k) early and is authorized to so.
How long does it take to receive money after you cash out a 401(k)?
You may have to wait for several weeks until you receive your funds. A 401(k) plan is a highly regulated retirement account subject to strict governance. Therefore, it may take a significant amount of time for the funds to be released.
Some plans may have rules that restrict them from giving out funds more than once a quarter or year. If your plan follows this rule, the time horizon can be extended to 30 – 90 days or more.
If you are contemplating cashing out your 401(k), but are concerned about its implications, be sure to consult a financial expert.
Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning company based in Goodyear, AZ. He has over three decades of experience working with investments and retirement planning, and over the last ten years has turned his focus to self-directed ira accounts and alternative investments. If you need help and guidance with traditional or alternative investments, call him today (866) 639-0066.