Before You Cash Out Your 401(k), Follow This Checklist
Written by
Angela Mae
Edited by
Chris Cluff
Commitment to Our Readers
GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.
20 Years
Helping You Live Richer
Reviewed
by Experts
Trusted by
Millions of Readers
People have many reasons for wanting to cash out their 401(k), such as sudden or unexpected financial hardships. While you may feel it’s necessary to cash out your plan early, it could end up being an expensive mistake if you’re not careful.
That’s why it’s important to understand the potential risks and consequences of cashing out your 401(k) before you actually do it. At the same time, there are certain steps you should take beforehand to minimize any negatives.
With that in mind, here’s a checklist of items you should take care of before deciding to cash out your 401(k), and how to go about it in a way that provides the most benefit to you.
Review Your Overall Financial Situation
“People often contemplate cashing out early due to unexpected situations like sudden medical expenses or job loss. These are valid reasons, but it’s vital to be aware of the associated risks and consequences,” said Eliza Arnold, founder at Arnie. “Before making such a move, it’s crucial to understand your overall financial situation thoroughly.”
Take some time to review your financial situation and consider alternatives before cashing out your 401(k). “Decisions like these have long-lasting impacts on your financial future,” Arnold said, “so don’t rush into anything.”
And remember: Once you’ve made the decision, there’s no going back. You can’t put the money you’ve withdrawn back into your 401(k). Any money you do withdraw will also no longer benefit from things like compound interest, which could set you back when it comes to retirement.
Speak With a Financial Advisor
An experienced financial advisor can help you make decisions pertaining to your finances, particularly when it comes to things like investing and retirement planning. So, if you’re thinking about cashing out your 401(k), consult with an advisor first.
“This isn’t a decision to take lightly, and sometimes seeking the advice of a financial advisor can help clarify the implications,” Arnold said. “It’s always best to consult with a financial advisor or tax professional who can provide guidance tailored to your unique situation.”
Jenn Schell, a financial researcher and writer for Annuity.org, added, “A trained professional can take a holistic look at your situation and help you decide whether withdrawing your 401(k) is the right call.”
Going with a financial advisor can be beneficial because the person can give you more of an unbiased look into your finances and help you make the best decision for your circumstances.
Review the Tax Penalties
If you choose to cash out your 401(k) plan early, you could be hit with a tax penalty. This penalty can significantly reduce your withdrawal amount. Depending on how much you have in the account, you might not have enough left to cover what you need.
“Withdrawing funds early from your 401(k) means you’ll be required to pay income taxes on the withdrawal amount,” said Todd Stearn, founder and CEO of TheMoneyManual.com.
You also could be hit with a 10% penalty if you withdraw before you’re 59.5 and don’t meet certain criteria.
“If you are in the 22% tax bracket and are charged that additional 10% penalty, that would be an automatic 32% cut on your money just for federal taxes,” added Kendall Meade, a CFP at SoFi. Along with this, you might also owe state taxes on the withdrawn amount.
Fortunately, there are ways to reduce certain penalties.
“Cashing out a qualified retirement plan before you reach retirement age — 59 1/2 years old — can have serious consequences,” Schell said. “You’ll likely lose 20% of your account’s balance to pay for taxes on top of a 10% early withdrawal penalty.
“One way to minimize the risk is to withdraw only part of the funds rather than cashing out the account, if possible,” Schell added. “Although you’ll still incur an early withdrawal penalty, it’s usually better if you can afford to leave some money in your retirement plan to continue accumulating value.”
See Whether You Qualify for a 401(k) Hardship Withdrawal
While it might be better to hold off on cashing out your 401(k), if you need the money and can’t wait, see whether you qualify for a 401(k) hardship withdrawal. This will get rid of the 10% early withdrawal penalty, but keep in mind that not everyone is eligible for this option.
“Your 401(k) plan rules will determine if this is possible,” Stearn said. “So, start by asking your plan administrator. Examples that may qualify you for the hardship withdrawal are medical expenses, home repairs, higher education expenses, funeral expenses, terminal illness and losses you’ve suffered due to a natural disaster.”
Consider Alternatives to Cashing Out Your 401(k)
Depending on what other investment vehicles you have at your disposal, you may want to consider using one of them instead of your 401(k) to cover any financial hardship you’re experiencing.
“If you have a Roth IRA, you may want to tap into this money first,” Meade said. “With a Roth IRA, you are able to withdraw any of your contributions — just the money you contributed, no earnings — at any time without penalties or taxes.”
Alternatively, consider using a low-interest personal loan. Or, if you have a decent amount of equity in your home, you may be able to use a home equity line of credit (HELOC) or a home equity loan instead.
Another possible option, depending on your 401(k) plan, is to use a 401(k) loan.
“This is an option where you can withdraw money from your 401(k) but continue paying it back out of your paychecks,” Meade said. “This option does typically have a lower interest rate, but your money will no longer be invested; and, if you leave your job, you may have to pay it back at an accelerated rate.”
Speak With Your Plan Provider
If you’re set on cashing out your 401(k), then it may be time to speak with your plan provider. If you’re not sure whom to talk to, contact your employer’s human resources department to get the information you need.
Once you get in touch with your provider, tell them what you plan to do. They’ll give you the next steps and guide you through the process.
More From GOBankingRates
