Cashing out your 401k
Considering a pre-retirement 401k withdrawal? Read this first to help decide.
The purpose of a 401k 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 401k account balance, but you might not be able to take a 401k withdrawal.
401k hardship withdrawal
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 401k plan. Also, if you receive a hardship withdrawal from the 401k 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 401k balance with you. If you roll over your 401k balance into an IRA or your new employer's retirement plan, your money will continue to grow for retirement.
A rollover quote literally means you will roll the money from one account to another, without the money actually being directly in your possession through the transaction.
It may be tempting to take the big lump sum from your 401k when you leave your job and put it into your hands instead of rolling it over into a new 401k or IRA. That's not financially responsible, though, as you will generally have to pay income taxes on the funds withdrawn as well as a 10% penalty tax unless you are age 59 1/2 or older.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 have recently found yourself unemployed, if you're leaving your job to go back to school or to start a business, or simply have debt — you may be better off borrowing the money you need or finding other sources of income to reach your objectives. That way, you can keep your retirement fund safe for its true purpose, retirement.
If you've left your employer and are over age 59½, you don't face the 10% federal tax penalty if you take your 401k 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 72, required minimum distributions (RMDs) will be necessary for any balance kept in the 401k plan. You should consult with your tax advisor before taking a taxable distribution from your 401k plan. If you're still employed, the 401k plan may limit withdrawals of your account balance even if you are age 59½ or older.