Cashing Out Your 401(k)

Is Cashing Out a 401(k) Ever a Good Idea?

Man leaving a job with a box of belongings

The purpose of a 401(k) plan is to help you save for retirement. When you participate in the plan, you may be able to take out a loan against your 401(k) account balance, but you might not be able to take a 401(k) withdrawal.

Hardship

Some plans will allow you to take out the money that you contributed in the event of a true hardship, such as high medical bills due to a serious illness in the family. Other hardship needs allowed by federal regulations, in addition to payments for certain medical expenses, are: costs related to the purchase of a principal residence; tuition and related educational fees and expenses; payments necessary to prevent eviction from, or foreclosure on, a principal residence; burial or funeral expenses; and certain expenses for the repair of damage to your principal residence. However, your employer may elect for all, some, or none of these needs to be eligible for hardship withdrawals from the 401(k) plan.  Also, if you receive a hardship withdrawal from the 401(k) plan, you may not be able to contribute to your account for six months. These withdrawals will generally be subject to both income tax and a 10% tax penalty (for participants under age 59½), so they need to be used as a last resort in a serious emergency.

Leaving your job

Of course, when you leave a job, you can take your 401(k) balance with you. If you roll over your 401(k) balance into an IRA or your new employer's retirement plan, your money will continue to grow for retirement.

That big lump sum that you receive when you leave your job may be tempting. You could just take the money and spend it on whatever you like instead of rolling it over.

That's not financially responsible, though, as you will generally have to pay income taxes on the funds withdrawn as well as a 10% penalty tax unless you are age 59 1/2 or older. That makes the withdrawal very expensive. So if you are leaving your job to go back to school or to start a business and can find a student loan or a small business loan with a low interest rate, you may be better off borrowing the money. Then, you can keep your retirement fund safe for retirement.

Tax considerations

If you have left your employer and are over age 59½, you don't face the 10% federal tax penalty if you take your 401(k) balance as a taxable distribution. You will have to pay taxes on the total amount withdrawn unless part of the funds are Designated Roth Contributions. Beginning at age 70½, required minimum distributions (RMDs) will be necessary for any balance kept in the 401(k) plan.  You should consult with your tax advisor before taking a taxable distribution from your 401(k) plan.  If you are still employed, the 401(k) plan may limit withdrawals of your account balance even if you are age 59½ or older.

Disclosures

Neither State Farm nor its agents provide tax or legal advice.