So you’ve made the tough choice and have decided to do a 401k cash out, now what? While it’s our least favorite option because you get hit with some pretty hefty penalties, we realize that sometimes it just needs to be done particularly when the economy is grim. We won’t guilt trip you here but I just want to say one last time that cashing out your 401k should be your absolute last option. Make sure that you have exhausted all of your other options to get money before you go this route. With that being said, we’re going to cover what it entails, how to do it and what penalties you may incur.
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.
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.