Cashing Out 401k – What does it mean?

Well obviously the term cashout is exactly as it sounds. You’re taking the money you invested in your 401k and instead of doing a direct rollover into a new 401k or a 401k rollover to IRA, you are going to take that money as cash in hand and use it for something important. There are only a handful of instances where you can do a 401k cash out and those are: when you leave an employer, you have a financial hardship, a disability or death, your employer terminates the plan, or you reach the age of 59 ½. As you can see you can’t just cash out willy nilly any time you want to.[ReviewAZON asin="1413310311" display="inlinepost"]

What is the penalty for cashing out a 401k?

The penalty on a 401k cash out is pretty steep, which is why it is so strongly discouraged by most people. Here is an example of how costly it can be. Let’s say that you have $10,000 in your 401k plan and you decide to do a cash distribution, you will be automatically hit with a 20% tax right from the get go. Then when you are preparing your taxes the next year you will also get hit with more taxes,  possibly another 10% or 20%. So your $10,000 has quickly dwindled into $6000. That means you practically gave away $4000 of your retirement money to the tax man and you have nothing left saved, unless you did a partial distribution if it was allowed. That does not look good for your retirement future.

There are some exemptions where you can avoid additional taxes or penalties and I’ll cover these in another article soon.

Another Option – 401k Rollover to IRA

Before we move on to the how, I wanted to mention another option that you may have instead of cashing out your 401k. This money is important to you and your future and so you want to exhaust all options. You should consider rolling your money into an IRA account and from there you can withdraw only the amount that you need. This will help you reduce the amount of taxes and penalties that you’ll have to pay.

How to cash out 401k?

The cashout process is pretty straight forward.

• You’ll want to talk to your human resources department or plan administrator, whoever handles your 401k paperwork for you company, and ask them for the appropriate paperwork. Each employer may have a different department that handles it so you’ll just want to get in touch with whoever is responsible for that. If this is an individual account you will need to contact the company that you opened the account with and ask them for the right paperwork.
• You’ll want to know exactly how much you are going to cashout. You could do a partial or a full cash distribution. It is important that you communicate properly what option you are going for. You do not want there to be any confusion as to whether this is a partial of full 401k cash out.
• Turn in your paperwork to the plan administration or appropriate department. You can choose whether you would like to have a check for the amount of or you can have it transferred electronically to your personal account.
• Once you have received your funds, ensure that the amount is accurate.

Common Phrases:
cashing in 401k, tax penalty for cashing out 401k, How to cash out 401k

If you leave a company and decide to physically receive a part of or all of your 401k assets, this is considered a cash distribution. You may think, “This is my money so I will take it and run”, and the truth is, yes, you can take the money and run but not without paying some hefty taxes first.  State and federal income taxes will take a portion out of your distribution.  When you made the contributions to your 401k you probably did so with pre-taxed dollars.  Your employer contributions were also tax deferred.  When you go with a cash distribution you pay income tax on all pre-taxed earnings. Then there is a mandatory withholding of taxes of 20%.  Yep, you read that right, 20%. So if you had $50,000 in your retirement account and you cashed out your distributions you would pay $10,000 in taxes that your previous employer must pay to the IRS.  If you are still considering this, you also may have to pay a 10% penalty called a premature distribution for withdrawing from the account if you are under the age of 59 1/2 at the time you decided to leave the company.  Essentially if you had $50,000 you would have to pay $5,000 for penalties.  So if you add all the taxes you will pay your $50,000 is now $35,000 or less all because you cashed out early [ReviewAZON asin="1413310311" display="inlinepost"]

Unfortunately, the only benefit to this option is that you have hard cash in your hands now, rather than later.  So if you are in a financial crisis, and by crisis I mean serious medical injuries or tying to save your home, not buy a new wardrobe, then this would be a good option for you to take if you are willing to take the big financial hit.  We all know the tax man is going to get any money he can from us but this is also to deter you from withdrawing early.  The point of a retirement savings account is so that it can continue to grow and earn you money so you can one day retire.  If you withdraw early you have now taken a big chunk of that money and thrown it away.  Please think about your options and look into the 401k rollover options available whether it’s a 401k rollover to IRA or 401k rollover into your new employer’s retirement plan.  A cash distribution option is not something to take lightly. The money in hand seems nice but you will miss it greatly when you are retired! You may need to seek the advice of a tax adviser if you are still unsure about taking a cash out or if you need a third party to help you decide whether this is your best financial option.

Summary:

• Cash Distributions are only a good idea if you are in a financial crisis and need the money.  Speak with a tax advisor or 401k professional to determine if this is your best option.
• You will get dinged quite a bit by the tax man for cashing out early
• If you are unsure of what to do with your money, leave it in your current 401k plan until you have done some research or consulted with a professional regarding your next move