The price of cashing out your 401(k)

Cashing Out a 401(k): What a 401(k) Early Withdrawal Really Costs

The price of cashing out your 401(k)

Contributing to a 401(k) can be a “Hotel California” kind of experience: It’s easy to get your money in, but it’s hard to get your money out.

That is, unless you’re at least 59½ years old — that’s when the door swings wide open for a 401(k) withdrawal.

But try cashing out a 401(k) with an early withdrawal before that magical age and you could pay a steep price if you don’t proceed with caution.

Three consequences of a 401(k) early withdrawal or cashing out a 401(k)

  1. Taxes will be withheld. The IRS generally requires automatic withholding of 20% of a 401(k) early withdrawal for taxes. So if you withdraw $10,000 from your 401(k) at age 40, you may get only about $8,000. Keep in mind that you might get some of this back in the form of a tax refund at tax time if your withholding exceeds your actual tax liability.

  2. The IRS will penalize you. If you withdraw money from your 401(k) before you’re 59½, the IRS usually assesses a 10% penalty when you file your tax return. That could mean giving the government $1,000 of that $10,000 withdrawal. Between the taxes and penalty, your immediate take-home total could be as low as $7,000 from your original $10,000.

  3. It may mean less money for your future. That may be especially true if the market is down when you make the early withdrawal. “If you're pulling funds out, it can severely impact your ability to participate in a rebound, and then your entire retirement plan is offset,” says Adam Harding, a certified financial planner in Scottsdale, Arizona.

How long does it take to cash out a 401(k) after leaving a job?

Depending on who administers your 401(k) account (typically a brokerage, bank or other financial institution), it can take between 3 and 10 business days to receive a check after cashing out your 401(k). If you need money in a pinch, it may be time to make some quick cash or look into other financial crisis options before taking money a retirement account.

1. See if you qualify for an exception to the 10% tax penalty

Generally, the IRS will waive it if any of these situations apply to you:

  • You choose to receive “substantially equal periodic” payments. Basically, you agree to take a series of equal payments (at least one per year) from your account. They begin after you stop working, continue for life (yours or yours and your beneficiary’s) and generally have to stay the same for at least five years or until you hit 59½ (whichever comes last). A lot of rules apply to this option, so be sure to check with a qualified financial advisor first.
  • You leave your job. This works only if it happens in the year you turn 55 or later (50 if you work in federal law enforcement, federal firefighting, customs, border protection or air traffic control).
  • You have to divvy up a 401(k) in a divorce. If the court’s qualified domestic relations order in your divorce requires cashing out a 401(k) to split with your ex, the withdrawal to do that might be penalty-free.

Other exceptions might get you the 10% penalty if you're cashing out a 401(k) or making a 401(k) early withdrawal:

  • You become or are disabled.
  • Payments were made to your beneficiary or estate after you died.
  • You gave birth to a child or adopted a child during the year (up to $5,000 per account).
  • The money paid an IRS levy.
  • You were a victim of a disaster for which the IRS granted relief.
  • You overcontributed or were auto-enrolled in a 401(k) and want out (within certain time limits).
  • You were a military reservist called to active duty.

2. See if you qualify for a hardship withdrawal

A hardship withdrawal is a withdrawal of funds from a retirement plan due to “an immediate and heavy financial need.” A hardship withdrawal usually isn't subject to penalty. Generally, these things qualify for a hardship withdrawal:

  • Medical bills for you, your spouse or dependents.
  • Money to buy a house (but not to make mortgage payments).
  • College tuition, fees, and room and board for you, your spouse or your dependents.
  • Money to avoid foreclosure or eviction.
  • Certain costs to repair damage to your home.

How to make a hardship withdrawal

Your employer’s plan administrator usually decides if you qualify for a hardship withdrawal. You may need to explain why you can’t get the money elsewhere.

You usually can withdraw your 401(k) contributions and maybe any matching contributions your employer has made, but not normally the gains on the contributions (check your plan).

You may have to pay income taxes on a hardship distribution, and you may be subject to the 10% penalty mentioned earlier.

3. Consider converting your 401(k) to an IRA

Individual retirement accounts have slightly different withdrawal rules from 401(k)s. So, you might be able to avoid that 10% 401(k) early withdrawal penalty by converting your 401(k) to an IRA first. (Be sure that you understand the investment and fee differences between 401(k)s and IRAs, of course.) For example:

  • There’s no mandatory withholding on IRA withdrawals. That means you might be able to choose to have no income tax withheld and thus get a bigger check now. (You still have to pay the tax when you file your return, though.) So if you’re in a desperate situation, rolling the money into an IRA and then taking the full amount the IRA might be a way to get 100% of the distribution. This strategy may be valuable for people in low tax brackets or who know they’re getting refunds. (See what tax bracket you're in here.)
  • School costs could qualify. Withdrawals for college expenses could be OK if they fit the IRS’ definition of “qualified higher education expenses.”

4. Take out the bare minimum when cashing out a 401(k)

“Anytime you take early withdrawals from your 401(k), you’ll have two primary costs — taxes and/or penalties — which will be pretty well-defined your age and income tax rates, and the foregone investment experience you could have enjoyed if your funds remained invested in the 401(k). This total cost should be considered in detail before making early withdrawals,” Harding says.

So, is it ever a good idea to cash out a 401(k)? Don’t make a 401(k) early withdrawal just to pay off debt or buy a car; early withdrawals from a 401(k) should be only for true emergencies, he says.

Even if you manage to avoid the 10% penalty, you probably will still have to pay income taxes when cashing out 401(k)s. Plus, you could stunt your retirement. “If you need $10,000, don’t make it $15,000 just in case,” Harding says.

“You can’t get it back in once it’s out.”


What You Need to Know Before Withdrawing From Your 401(k)

The price of cashing out your 401(k)

By Noah – January 13, 2021

The pandemic affected more than physical health in 2020. Business closures, job loss, and limited financial relief meant many Americans' savings accounts took a serious hit.

In 2020, The CARES Act made it easier to take a withdrawal from a 401(k) or other qualifying retirement account by waiving the usual penalty. More than 2 million Americans took advantage of this benefit last year.

We’re in a fresh new year, but the coronavirus pandemic is still going to have economic and health impact in 2021.

If you’re wondering how to make ends meet, there are several things you should know about short- and long-term impact of borrowing from your retirement funds, and what alternatives to consider.

How 401(k) Withdrawals Work

Normally, your contributions to a 401(k) retirement plan come pre-tax income. They then grow tax-free, and you pay taxes when you withdraw the money in retirement (when, presumably, you’re in a lower tax bracket than in your working years).

If you take a withdrawal before age 59 ½, it’s considered an early distribution of your retirement fund, and it’s subject to penalties. Typically, this means you'll have to pay income tax and a 10% penalty on the withdrawal amount.

There are some limited options for a “hardship withdrawal” or “hardship distributions” that waive the penalty. From January 1-December 30, 2020, the CARES Act waived the 401(k) early withdrawal penalty.

However the government did not extend this provision of the CARES Act for 2021.

The new legislation that does impact 2021 is called the Consolidated Appropriations Act, signed into law on December 27, 2020.

Although it does not extend the time to take a coronavirus-related distribution from your 401(k), it does allow people to take distributions if they are affected by qualified disasters other than the pandemic.

Qualified disasters include events that are declared disasters by the President between January 1, 2020 and 60 days after the enactment of The Act. You have 180 days from the enactment of The Act to take a qualified disaster distribution.

Pros and Cons of Cashing Out 401(k) Vs. a 401(k) Loan

An important question to ask yourself is whether you intend to pay the money back into your retirement plan.  The pros and cons of borrowing from 401(k) or other qualifying accounts are a little different from the pros and cons of withdrawing from a 401(k).

What is an early withdrawal from 401(k)?

A 401(k) is a retirement savings plan, so dipping into that money early comes with a 401(k) withdrawal penalty. COVID response in 2020 included a temporary lift on penalties on qualifying distributions, but this is no longer in effect for 2021.

The pro side is that the money is yours, minus whatever penalties and taxes you have to pay. You don’t need to figure out a repayment plan (or reinvestment, since you’re paying into your own account). The con side is that this option cuts retirement funds you’d planned to live on later, and you lose more up front to penalties, taxes, and fees.

What is a 401(k) loan?

Not all 401(k) plans allow a loan option, but many do. You can borrow from a 401(k) without penalty, as long as you can meet the amortized repayment schedule.

Funds you receive through a 401(k) loan aren’t subject to penalties or taxes if you repay on time, so you keep more of your money.

The “interest” is also really a payment to yourself, since it goes back into your 401(k) plan.

The interest can help recover some of the gains you might have earned from investment performance, so depending on how the market is doing, you may not see a loss from having money the market.

 If you don’t stick to the repayment schedule, however, you will face penalties and taxes on the portion that’s outstanding. The IRS will treat the amount you haven’t repaid on time as an early distribution, not a loan. Funds you pay back into your 401(k) also come from your after-tax dollars in your paycheck, not before-tax earnings.

Comparing interest rates on a 401(k) loan, interest rates on a bank loan, and expected returns from the market can help you determine whether a 401(k) loan is your most cost-effective option.

Alternatives to 401(k) Loan or Early Withdrawal

Just because you can tap into your 401(k) doesn’t mean it’s the best decision for your financial situation. Consider the full range of options before dipping into your 401(k) plan:

  • Roth IRA: Un a 401(k) or a Traditional IRA, you can cash out your Roth IRA contributions at any time.  Before withdrawing any earnings, consult a financial advisor to ensure you meet the conditions for a tax-free and penalty-free withdrawal.
  • Stock investments outside of your retirement portfolio: If your brokerage account balance is at a high, it may be reason to consider selling some of your shares to get some cash. Talk with a financial advisor about your portfolio’s performance and how to adjust your investment plan.
  • Home Value Investment: Tapping into your home equity can be a viable alternative to using retirement savings or other investments. You won’t be adding to your debt load, and you won’t lose out on possible long-term, compound earnings the way you might be withdrawing investments too early.
  • Home equity loan: Un a Home Value Investment, a home equity loan operates a traditional loan by charging interest and implementing a monthly payment plan. However these often require exceptional credit to qualify and the ability to take on more monthly payments.
  • Personal loan from a bank or other financial institution.  Personal loans often come with hefty interest rates and shorter durations than other types of financing.
  • Mortgage forbearance: This isn’t a source of funding, but it might be a way to ease some financial strain. Some lenders may accept initial requests for CARES Act mortgage forbearance until February 28, 2021. You’ll still have to pay the full balance of your mortgage eventually, but pausing your payments for a few months could help you get back on your feet.


Cashing Out a 401k

The price of cashing out your 401(k)

Most people have a 401k as their primary retirement savings plan through their employer. Each time you change employers, you will open a new 401k that is sponsored by your current employer.

If you change jobs every few years, you may end up with several different 401ks at a variety of companies. It can be difficult to track all of the 401ks that you have and you may want to look into rolling over your 401k or cashing out a 401k.

There are heavy 401k withdrawal penalties that you will have to pay if you are not 59 ½ when you cash out a 401k.

Reasons for Cashing Out a 401k

It’s important to remember that your 401k is the money you have set aside to pay for your future expenses. It is protected if you have to declare bankruptcy, while your other assets are not. Cashing out a 401k before you reach retirement age should be a last resort. Still, if you face any of the following situations, you may choose to cash out your 401k:

  • You may need to cash out your 401k to help pay bills while you are unemployed.
  • Cashing out a 401k may make sense when you are facing large medical bills.
  • You may cash out your 401k when there is a small amount of money in it.
  • You might consider cashing out a 401k to save your home or for a down payment on a home.
  • Consider a 401k cash out to cover education costs for your spouse or children.

401k Cash Out Basics

Cashing out a 401k is technically allowed when you leave an employer but that doesn’t make it the best financial decision. Understanding a few 401k cash out basics will help you decide if you want to complete the process or seek alternatives.

Cashing out a 401k before you reach the age of 59 1/2 is considered an early withdrawal by the IRS and you’ll pay a 10% penalty on the money you withdraw.

You’ll also need to report your 401k cash out as income on your taxes which could force you into a higher tax bracket, seriously putting a dent in the cash you received.

You’ll probably only see about 70% of your 401k cash out in the first place as most plan administrators withhold 30% for taxes and penalties.

Steps to Take for Cashing Out a 401k

It can take several weeks to successfully cash out a 401k. You should be prepared to handle a lot of paperwork. It is important to realize that this is not a solution for fast cash and you will only get a portion of your 401k cash out. You will need to begin the process before you need the actual cash.

  1. Contact the 401k administrator by looking for the number on your 401k statements.
  2. If you are still employed by the company who offers the 401k, you will not qualify to cash out your 401k, though you may qualify for a 401k loan or an early 401k withdrawals or hardship withdrawal. These options are available on some plans, but not all of them. You can learn more about your specific plan by contacting your human resources representative.
  3. Fill out the 401k rollover forms that the 401k company sends you. You will need to fill it out as instructed and be prepared to pay taxes on the money that you withdraw.

Penalties and Taxes on Cashing out a 401k

When you complete a 401k cash out, you will need to pay an early withdrawal penalty and 401k taxes on your withdrawal. The 401k early withdrawal penalty is 10% of the amount that you withdraw. You will also be taxed at your normal income rate on the amount that you withdraw.

Most plans will withhold 20% of the amount that you withdraw and send it to the IRS to help cover the costs and will send you a 1099-R form. If your tax rate is higher than 10%, then you will need to be prepared to pay additional money when you file your taxes.

It is important to be prepared for this possibility.

Alternatives to Cashing Out a 401k

It is highly recommended that you never take a 401k cash out. The money is there to secure your financial independence in retirement. That’s only possible if it’s allowed to grow to meet your income needs.

Cashing out just $10,000 at the age of 40 years old will cost you over $60,000 by the time you reach 60 years old assuming a 33% tax bracket and 7% annual return.

Taxes and withdrawal penalties would cost you an immediate $4,300 of that amount.

If you need money, there are alternatives to cashing out a 401k. These options are available while you are still working with the employer that manages the 401k.

  • Consider a home equity line of credit (HELOC) or other low-interest loan before cashing out a 401k plan. Personal loans and other types can carry high interest rates but may still cost less than the taxes and penalties you’ll pay on a 401k cash out
  • Go into emergency spending mode. Cut out all non-essential spending for a few months before considering cashing out a 401k. Talk with your creditors to get extensions where you can and avoid digging yourself deeper in debt
  • Borrow or withdraw from Roth IRAs first. You may still be jeopardizing your retirement goals but you’ve already paid taxes on money contributed to a Roth account so it may ultimately be cheaper than a 401k cash out

Hardship Withdrawals on Your 401k Cash Out

You can take a hardship withdrawal if you are facing a serious financial emergency. The hardship withdrawal has the same penalties that you will have when you cash out your 401k, but it does allow you to take out money from the 401k plan to which you are currently contributing. There are various annual limits and rules surrounding the withdrawal that you will have to follow.

Hardship withdrawals on your 401k account are generally allowed before you reach 59 1/2 under the following circumstances:

  • You become permanently or completely disabled
  • Medical expenses that exceed 7.5% of your gross income
  • You need to withdraw from the account to split funds in a divorce
  • To pay for your first home or to prevent eviction or foreclosure

Understand that even if you avoid paying the 10% penalty on your 401k withdrawal, you will still need to pay income taxes on the amount you collect.

401k Loans

Another option is to take out a 401k loan. Again, you will need to meet the conditions that will allow you to take out the loan, such as for a down payment on your home.

The plan will set up a payment plan, and you will need to pay the loan off in a timely manner.

If you are laid off, or change employers, the remaining amount of the loan will be due, or you will face the taxes and early withdrawal penalties on the amounts that you still owe to the company.

Rollover Your 401k instead of Cashing Out

If you are having a difficult time keeping track of your various 401ks or if you want more control over the investments within your retirement plan, you should consider rolling your 401k over into an IRA. This gives you more control over your retirement savings, and can make it easier to track your accounts. You can contact us to find out more about rolling over your 401k and to find the right IRA for you.


The High Price of a 401(k) Withdrawal

The price of cashing out your 401(k)

Life has a way of throwing curve balls at us. And they’re great at draining us of our money—especially if we’re not prepared. You’ve heard of Murphy’s Law, right? Anything that can go wrong will go wrong. Murphy is rude. He doesn’t even knock when he shows up—he just kicks down the door!

The coronavirus pandemic is the biggest financial crisis that a lot Americans have ever seen. If you’re scared right now about emergency expenses or paying down debt, you might be tempted to take money from your 401(k), especially considering the new loopholes in the CARES Act that Congress recently passed.

But is a 401(k) withdrawal a good idea? Let’s jump into the details to find out.

401k Early Withdrawal Penalties

If you take money your traditional 401(k) before age 59 1/2, you’ll get hit with two big bills when you file your next tax return:

  1. Income taxes on your withdrawal
  2. An early withdrawal penalty of 10%

Let’s say you make $60,000 a year and you withdraw $20,000 from your 401(k) to pay for medical bills. You’re in the 22% tax bracket, which means that Uncle Sam pockets $4,400 of your 401(k) money for income taxes and $2,000 for that 10% penalty. In the end, you’re only left with $13,600 of your original $20,000. That’s outrageous! There are better ways to pay the bills.

Be confident about your retirement. Find an investing pro in your area today. 

But taxes and penalties are just the beginning of the money you’ve lost. You’re also robbing from your future self. Here’s what I mean: Let’s say you left that $20,000 alone for 25 years and it averaged a 10% annual growth rate in a good mutual fund. That $20,000 would eventually turn into more than $240,000, and you’d never even have to lift a finger!

Here’s the reality: Your 401(k) is a retirement account that’s designed for long-term wealth building. It’s not supposed to pay for emergencies or be your college tuition fund for little Suzy. 

What About 401k Hardship Withdrawals?

A hardship withdrawal is a special circumstance when the IRS allows you to take money your 401(k) without the 10% withdrawal fee (although you’ll still have to pay income taxes).

According to the IRS, a hardship withdrawal applies to people in an “immediate or heavy need.” These circumstances apply to you, your spouse or your dependents. And by the way, the IRS makes sure to throw this qualifier in there: “Expenses for the purchase of a boat or television would generally not qualify for a hardship distribution.”1  Hold up . . . is that the IRS making jokes?

These six circumstances qualify for a hardship withdrawal:

  1. Medical expenses 
  2. Costs relating to the purchase of a principal residence
  3. Tuition and related educational fees and expenses
  4. Payments necessary to prevent eviction or foreclosure (of your primary residence)
  5. Burial or funeral expenses
  6. Certain expenses to repair damage to your principal residence2

Also, I should mention here that the SECURE Act, which was passed in December of 2019, gave new parents the option to withdraw up to $5,000 penalty-free to pay for birth or adoption expenses for a new child.3

Keep in mind that each retirement plan varies, and your employer is not required to make hardship withdrawals an option for your plan. For example, some may not allow for tuition expenses, and others do. Check with your HR department if you have questions about your specific plan.

Hear me on this, people: Even if you qualify for a hardship withdrawal, it’s a bad idea to raid your own nest egg. You’ll still have to pay income taxes, plus you’ll miss out on compound growth of the money you take out.

401(k) Withdrawals Under the CARES Act

The CARES Act, a federal stimulus package that was signed into law on March 27, created a new type of “hardship withdrawal” to help people who have been hard hit by the coronavirus pandemic.

Those who have lost a job due to the virus, are sick, or are caring for a sick spouse or dependent can withdraw from their retirement accounts without paying the 10% withdrawal penalty.

Once again, you’ll still have to pay income taxes on the amount you withdraw, although there’s flexibility in the repayment—you can pay the taxes over three years if needed.4

You can take up to $100,000 for these types of withdrawals:

  • 401(k) distribution
  • 401(k) loan
  • IRA withdrawal

The difference between the 401(k) loan and distribution is that with the distribution, you just bite the bullet and pay the taxes now, but with a loan, you’re supposed to “repay yourself” eventually, and therefore you avoid paying taxes. Typically, a 401(k) loan only allows borrowers to take up to $50,000, but the CARES Act doubles the normal amount for the next six months.

Should You Withdraw Money Early From Your 401k?

The answer is big no: It’s almost never the right decision. There are three reasons why you shouldn’t turn to your 401(k) to pay down debt or emergency expenses: 

1. You’re paying a fortune in fees and penalties. 

We’ve already been over this, but let me remind you one more time: When you take an early distribution from your 401(k), you’ll pay Uncle Sam income taxes on that money plus a 10% withdrawal fee.

2. You’re robbing your retirement dreams. 

The two most powerful forces in all of finance are time and compound growth. Think of saving for retirement growing a tree. It takes decades for most trees to reach full height. If you drain your 401(k) now, it’s uprooting a tree—you’ll have to start over again with a tiny little seed.

3. You’re executing a bad financial game plan. 

I’m a big sports guy, so let me give you an analogy from football. Taking money your 401(k) is throwing a Hail Mary pass—it’s a last-ditch attempt to solve a desperate problem. That’s not how champions play, people! They win by consistently executing a proven game plan over time that sets them up for victory. 

The only time you should withdraw money from or cash out your 401(k) is to avoid bankruptcy or foreclosure—and that’s only if you’ve exhausted all other options, taking on extra jobs and a short sale on your house.

You Have Better Options Than Draining Your 401(k) 

Listen, I understand—a big, unexpected expense or a job loss will make you feel overwhelmed, frightened and trapped. So, you need to hear this: You do have options, and they’re much better than robbing your retirement fund. It might take some sacrifice, but if you stay focused, I know you can overcome this.

Instead of taking money from your 401(k), I want you to try one or all of these options:

  • Go into conserve mode. If you’re in a true financial crisis, it’s time to cut all unnecessary spending: the gym, entertainment and online shopping. It might even be time to sell your car. Get on a budget and take control of your money. Now, if you’re taking money from your retirement to pay for school for your child, then it’s time for some real talk. You don’t have to pay for Junior’s dream school. You and your child have options to get them through college debt-free that don’t involve stealing from your retirement.
  • Work out a payment plan. Whether you owe money to the IRS or to a lender, call them up and explain your situation. See if you can break out that big amount into smaller payments over a set period of time.
  • Ask for help from family or friends. No, I’m not recommending that you ask them for money, but you might be able to get some nonmonetary help. Maybe you could save childcare expenses by asking a parent to watch your kids. Or if you’re in a really desperate place, being unable to pay rent, you could move in with family until you’re back on your feet.
  • Take on extra work. It’s a temporary sacrifice that sets you up for long-term success. Debt keeps you trapped. And borrowing from your 401(k) robs you of your future. Do what you have to do right now to keep from adding to your debt or draining your 401(k).

Let’s go back to that football analogy. If you want to play a champion, you need a game plan for your money. It’s called the 7 Baby Steps—the proven plan for getting debt and building wealth. If you take these steps, you’ll put yourself in a position where you never feel tempted to withdraw from your 401(k) again.

Ready to take control of your money? Find hope today by signing up for a free trial of Ramsey+, an all-access membership that gives you everything you need to budget, pay off debt, and begin building wealth. Start your FREE trial of Ramsey+.


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