It’s a basic but all-too common question posed on financial blogs like this one: “I just left my job. I have like $1,000 sitting in my old 401(k) and I’m short on cash. Can I just cash out the 401(k)?”
About cashing out old 401(k)s
Technically, yes: After you’ve left your employer, you can ask your plan administrator for 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 59 ½ years 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 percent penalty on top of regular income taxes.
In most cases, your plan administrator will mail you a check for 70 percent of your 401(k) balance. That’s your balance minus: 10 percent for the withdrawal penalty and 20 percent to cover federal income taxes (depending on your tax bracket, you may owe more or less when you file your return).
Its financially prudent to save for retirement and leave that money invested. But paying the 10 percent early withdrawal penalty is just dumb money — it’s equivalent to taking money you’ve earned and tossing it out the window.
What about my current 401(k)? Can I access that money anytime?
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. You can cash out your 401(k) before age 59 ½ without paying the 10 percent penalty if:
- You become completely and permanently disabled
- You incur medical expenses that exceed 7.5 percent 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, terminated, quit, or retired and have established a payment schedule of regular withdrawals in equal amounts for the rest of your expected natural life.
Additionally, you can cash out your 401(k) and pay the 10 percent 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, 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.
If you start early and let the money grow, over time your 401(k) could hit $1 million! Cashing out now means giving up much more money in the future:
- The $1 million 401(k): investing strategy for 20- and 30-somethings
- How much should be in your 401(k) at 30?
Editor’s note: This article was originally published in January 2013. It has been thoroughly updated for relevance and accuracy.
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