Cashing Out a 401(k): What a 401(k) Early Withdrawal Really Costs

It's fairly easy to put money into a 401(k), but getting your money out can be a different story. That is, unless you’re at least 59½ years old — that’s when the door swings wide open for a qualified 401(k) withdrawal.

But the current high inflation, rising interest rates and rocky stock market have some investors itching to cash out early. In a November 2022 Wells Fargo & Company study, 42% of investors interviewed said they wanted to cash out of their investments, and 29% said they would cash out a 401(k) or IRA if they could avoid paying penalties.^[0]

If you're thinking of cashing out a 401(k) before you reach 59½, proceed with caution. You could pay a steep price.

» Dive deeper: What to do when the stock market is crashing

Three consequences of a 401(k) early withdrawal or cashing out a 401(k)

1. Taxes will be withheld. The IRS generally requires automatic withholding of 20% of a 401(k) early withdrawal for taxes. So if you withdraw $10,000 from your 401(k) at age 40, you may get only about $8,000. Keep in mind that you might get some of this back in the form of a tax refund at tax time if your withholding exceeds your actual tax liability.

2. The IRS will penalize you. If you withdraw money from your 401(k) before you’re 59½, the IRS usually assesses a 10% tax as an early distribution penalty. That could mean giving the government $1,000, or 10% of that $10,000 withdrawal, in addition to paying ordinary income tax on that money. Between the taxes and penalty, your immediate take-home total could be as low as $7,000 from your original $10,000.

3. You may lock in your losses. That may be especially true if the market is down when you make the early withdrawal. “If you're pulling funds out, it can severely impact your ability to participate in a rebound, and then your entire retirement plan is offset,” says Adam Harding, a certified financial planner in Tempe, Arizona. That may mean less money for your future.

How long does it take to cash out a 401(k) after leaving a job?

Depending on who administers your 401(k) account, it can take between three and 10 business days to receive a check after cashing out your 401(k). If you need money in a pinch, it may be time to make some quick cash or look into other financial crisis options before taking money out of a retirement account.

If you're still thinking about cashing out a 401(k) or taking a 401(k) early withdrawal

1. See if you qualify for an exception to the 10% tax penalty

Generally, the IRS will waive it if any of these situations apply to you:

• You choose to receive “substantially equal periodic” payments. Basically, you agree to take a series of equal payments (at least one per year) from your account. They begin after you stop working, continue for life (yours or yours and your beneficiary’s) and generally have to stay the same for at least five years or until you hit 59½ (whichever comes last). A lot of rules apply to this option, so be sure to check with a qualified financial advisor first.

• You leave your job. This works only if it happens in the year you turn 55 or later (50 if you work in federal law enforcement, federal firefighting, customs, border protection or air traffic control).

• You have to divvy up a 401(k) in a divorce. If the court’s qualified domestic relations order in your divorce requires cashing out a 401(k) to split with your ex, the withdrawal to do that might be penalty-free.

Other exceptions might get you out of the 10% penalty if you're cashing out a 401(k) or making a 401(k) early withdrawal:

• You become or are disabled.

• You rolled the account over to another retirement plan (within a certain time).

• Payments were made to your beneficiary or estate after you died.

• You gave birth to a child or adopted a child during the year (up to $5,000 per account).

• The money paid an IRS levy.

• You were a victim of a disaster for which the IRS granted relief.

• You over-contributed or were auto-enrolled in a 401(k) and want out (within certain time limits).

• You were a military reservist called to active duty.

Finally, a provision in the Secure 2.0 Act, which became law at the end of 2022 and revised many of the government's rules for retirement plans, will allow special emergency distributions of up to $1,000 per year beginning in 2024.

2. See if you qualify for a hardship withdrawal

A hardship withdrawal is a withdrawal of funds from a retirement plan due to “an immediate and heavy financial need.” A hardship withdrawal usually isn't subject to penalty.

Generally, these things qualify for a hardship withdrawal:

• Medical bills for you, your spouse or dependents.

• Money to buy a house (but not to make mortgage payments).

• College tuition, fees, and room and board for you, your spouse or your dependents.

• Money to avoid foreclosure or eviction.

• Funeral expenses.

• Certain costs to repair damage to your home.

How to make a hardship withdrawal

Your employer’s plan administrator usually decides if you qualify for a hardship withdrawal. You may need to explain why you can’t get the money elsewhere. You usually can withdraw your 401(k) contributions and maybe any matching contributions your employer has made, but not normally the gains on the contributions (check your plan). You may have to pay income taxes on a hardship distribution, and you may be subject to the 10% penalty mentioned earlier.

3. Consider converting your 401(k) to an IRA

Individual retirement accounts — known as IRAs — have slightly different withdrawal rules from 401(k)s. You might be able to avoid that 10% 401(k) early withdrawal penalty by converting an old 401(k) to an IRA first. For example:

• There’s no mandatory withholding on IRA withdrawals. That means you might be able to choose to have no income tax withheld and thus get a bigger check now. (You still have to pay the tax when you file your tax return.) If you’re in a desperate situation, rolling the money into an IRA and then taking the full amount out of the IRA might be a way to get 100% of the distribution. This strategy may be valuable for people in low tax brackets or who know they’re getting refunds. (See what tax bracket you're in.)

• You can take out up to $10,000 for a first-time home purchase. If that's why you need this cash, converting to an IRA first may be a better way to access it.

• School costs could qualify. Withdrawals for college expenses could be OK from an IRA, if they fit the IRS’ definition of qualified higher education expenses ^[0]

  IRS.gov. Qualified Education Expenses.

  View all sources

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» Learn more: IRA vs. 401(k): How to Choose

4. Take out the bare minimum when cashing out a 401(k)

“Anytime you take early withdrawals from your 401(k), you’ll have two primary costs — taxes and/or penalties — which will be pretty well-defined based on your age and income tax rates, and the foregone investment experience you could have enjoyed if your funds remained invested in the 401(k). This total cost should be considered in detail before making early withdrawals,” Harding says.

Don’t make a 401(k) early withdrawal just because you're nervous about losing money in the short term. It's also not a great idea to cash out your 401(k) to pay off debt or buy a car, Harding says. Early withdrawals from a 401(k) should be only for true emergencies, he says.