Written by David Weliver • Edited by Chris Muller • Last updated on September 13, 2023
Can you cash out your 401(k) and take the money? Technically, yes. But you should do everything you can to avoid it. Cashing out early will cost you huge in penalties and lost growth over the next few decades.
It’s a basic but all too common question posed on financial blogs like this one: “I just left my job. I have $1,000 sitting in my old 401(k) and I’m short on cash. Can I just cash out the 401(k)?”
Today we answer this simple question.
Just because you can cash out your 401(k) doesn’t mean you should
Technically, yes: After you’ve left your employer, you can ask your planadministratorfor a cash withdrawal from your old 401(k). They’ll close your account and mail you a check.
But you should rarely—if ever—do this until you’re at least 59½years old!
Let me say this again: As tempting as it may be to cash out an old 401(k), it’s a poor financial decision. That’s because, in the eyes of the IRS, cashing out your 401(k) before you are 59 ½ is considered an early withdrawal and is subject to a 10% penalty on top of regular income taxes. Oh, yes, that’s another thing: Since the 401(k) is funded with pre-tax money, you also have to pay taxes on it when you cash out.
In most cases, your planadministratorwill mail you a check for 70% of your 401(k) balance. That’s your balance minus 10% for the withdrawal penalty and 20% to cover federal income taxes (depending on your tax bracket, you may owe more or less when you file your return).
It’s financially prudent to save for retirement and leave that money invested.But paying the 10% early withdrawal penalty is just dumb money — it’sequivalentto taking money you’ve earned and tossing it out the window.
What about my current 401(k)? Can I access that money at any time?
You cannot take a cash 401(k) withdrawal while you are currently working for the employer that sponsors the 401(k) unless you have a major hardship. That being said, you can cash out your 401(k) before age 59 ½ without paying the 10% penalty if:
- You become completely and permanently disabled
- You incur medical expenses that exceed 7.5% of your gross income
- A court of law orders you to give the funds to your divorced spouse, a child, or a dependent
- You retire early in the same year you turn 55 or later
- You are permanently laid off or terminated, you quit, or you retire and have established a payment schedule of regular withdrawals in equal amounts forthe rest of your expected natural life.
Additionally, you can cash out your 401(k) and pay the 10% penalty if you need funds for certain financial hardships and have no other source of funds. These hardships include:
- The purchase of your primary home
- Higher education tuition, room and board, and fees for the next twelve months for you, your spouse, or your dependents or children
- To prevent eviction from your home or foreclosure on your primary residence
- Tax-deductible medical expenses that are not reimbursed for you, your spouse, or your dependents
- Other severe financial hardship
Even if you meet these requirements, cashing out your 401(k) should always be seen as an absolute last resort.
Compound interest only works if you leave the money alone
We talk a lot at Money Under 30 about compound interest. It’s what makes a comfortable retirement possible for most of us. When you cash out your 401(k) early, you’re not just subtracting thatbalancefrom your eventual retirement fund. Rather, you’re deducting your balance, plus any interest your balancewill earn over the next few decades, plus the interest the interest would earn! Taking a few hundred bucks now could cost you thousands down the road. Not to mention that you immediatelylose almost 30% of your balance to taxes and fees.
It might feel like a small windfall now, but over the long term, you’re taking yourself to the cleaners.
Most retirement funds are set up to allow your money to grow with few interruptions: Hence why the money you put into a 401(k) isn’t taxed, why the interest you earn while your money is in the 401(k) isn’t taxed, and why it’s relatively hard to remove money from your account until you’re close to retirement age.
While we know it’s tempting to take that small pot of cash, we urge you to resist. And once you’ve gotten a new job, you should roll your old 401(k) into your new employer’s plan. That’ll take away the temptation entirely.
Summary
When you’re in a tight spot and need cash, your old 401(k) can look like a convenient pot of gold. But the long-term damage to your retirement fund isn’t worth the temporary boost to your bank account.
I'm an enthusiast with extensive knowledge in personal finance, particularly in the realm of retirement planning and 401(k) management. My expertise is grounded in practical experience and a deep understanding of the intricacies of financial instruments. Now, let's delve into the concepts discussed in the provided article:
1. Cashing Out 401(k) Early
The article emphasizes that while it is technically possible to cash out a 401(k) after leaving an employer, doing so before reaching the age of 59½ is generally ill-advised. The primary reason is the imposition of a 10% early withdrawal penalty by the IRS, in addition to regular income taxes. The article strongly discourages this practice due to the significant financial implications and lost growth potential over the long term.
2. Penalties and Taxes
The article explains that cashing out a 401(k) early incurs a penalty of 10% on top of regular income taxes. Since 401(k) contributions are made with pre-tax dollars, taxes are owed when withdrawing the funds. The author warns readers that, in most cases, they will receive only 70% of their 401(k) balance after accounting for the penalty and taxes.
3. Accessing Current 401(k)
The article clarifies that accessing funds from a current 401(k) while still employed is generally restricted, except in cases of major hardships. However, it lists specific scenarios where early withdrawals may be allowed without the 10% penalty, such as disability, medical expenses exceeding 7.5% of gross income, court orders, early retirement at 55 or later, permanent layoffs, or established payment schedules in retirement.
4. Financial Hardships for Early Withdrawals
The article outlines specific financial hardships that may allow for a 401(k) early withdrawal with a 10% penalty. These include purchasing a primary home, higher education expenses, preventing eviction or foreclosure, tax-deductible medical expenses, and other severe financial hardships. The author, nonetheless, emphasizes that cashing out should be a last resort even if these criteria are met.
5. Compound Interest
A key concept highlighted in the article is compound interest, which is crucial for long-term retirement savings. The article warns that cashing out a 401(k) early not only subtracts the current balance but also eliminates the potential interest and compounded growth over the coming decades. This loss, coupled with taxes and fees, could have a substantial impact on the overall retirement fund.
6. Long-Term Consequences
The article strongly advises against cashing out a 401(k) for immediate financial needs, emphasizing the long-term damage to retirement funds. It points out that what may seem like a small financial gain in the short term could translate into significant losses over the years. The recommendation is to resist the temptation and, upon finding new employment, to roll the old 401(k) into the new employer's plan to preserve retirement savings.
In summary, the article provides a comprehensive overview of the potential consequences of cashing out a 401(k) early, stressing the importance of considering long-term financial goals and the impact on retirement savings.
