I Want to Cash Out My 401(k) – What Do I Need to Know?

5792635506_697faa416d_zImage credit: Miran Dalone

Cashing in your 401(k) is something that has crossed the minds of many Americans today in order to make ends meet, whether in response to an emergency, to put a child through school, or to help a friend or loved one. It certainly can be quite tempting to cash out your 401(k) retirement plan when it seems as if that money is simply sitting there and taking up space when it could be put to good use.

Before you make any decisions regarding cashing out, be aware that there will be consequences of this choice. Should you cash out your total 401(k) amount, you will immediately owe income tax on the entire chunk of change.

If you are under the age of 59 1/2 years old, you will also be charged a 10% early withdrawal penalty fee on top of paying taxes on the amount you cash out. That can put a pretty significant dent in your “take-home” amount.

Your 401(k) and other similar contribution accounts are funded with money from your paycheck before taxes. This is beneficial for you because, by taking money from your paycheck and putting it into your retirement fund, the amount of income you are taxed on lowers, bringing down your income tax bill. Naturally, you will have to pay taxes on your 401(k) money when it is withdrawn later in life, but you will not be penalized the extra 10% if you wait until you are age 59 1/2 or older to tap into those resources.

Another reason to resist cashing out your 401(k) early, is that, in some cases, you may be getting a matching contribution from your boss. These can range from fifty cents to a dollar for each dollar contributed by you. By cashing out early, you are essentially giving up this free money! Additionally, matching contributions aren’t taxed until retirement – which means your tax bill will remain the same while you are essentially making more money.

One exception is something called a Roth 401(k). This version of your retirement savings plan works in reverse to the traditional 401(k). To clarify, you will pay taxes on money as you contribute to this type of plan, so you won’t see an immediate tax break. However, you won’t be paying any taxes upon withdrawing money from a Roth 401(k) in retirement. This means that any money contributed to this account is free to compound – tax-free – without limit.

Let’s say you are considering cashing out your 401(k) to help a friend or loved one in need. In other words, you will essentially be gifting the money you take out. Unfortunately, simply because you are choosing to be generous with your savings does not afford you a tax break, and you will still be charged the full income tax amount on your 401(k) total. Luckily, you probably won’t have to pay gift tax – unless your account contains upwards of $5 million, which is the limit for tax free gifts throughout your lifetime.

Also keep in mind that if you withdraw $14,000 or less and gift that amount, you do not have to report it to the IRS. If you withdraw more than $14,000 as a gift, you will have to fill out form 709 “United States Gift Tax Return.”

The bottom line about cashing out your 401(k) for things other than retirement is this: Do your research. Make sure that you’re making the wisest decision possible given your current circumstances. If you need help determining whether or not you should raid your retirement account, contact an attorney with experience in the area(s) of Estate Planning and/or Bankruptcy.

One Response to I Want to Cash Out My 401(k) – What Do I Need to Know?

  1. Pingback: Avoiding Debt Traps: Pay Day Loans, Rapid Refunds & Co-Signing | Veitengruber Law

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