Cash Out Your 401(k) While Still Employed: 3 Ways To Do It

A 401(k) plan is essential to your retirement strategy if you want to help ensure financial security. Although the funds you invest in your plan are for retirement, if you are in a situation where you have few other alternatives, you may be able to cash out your 401(k) while you’re still employed.  This is often referred to as an “in-service withdrawal”.

If you’re facing a large unexpected expense or particularly difficult financial hardship, you can access the funds you own in your 401(k), but there may be a penalty for early withdrawal if you’re under 59-½ in addition to federal (and possibly state) income tax implications. Thankfully, the IRS offers a few exemptions to the early withdrawal penalty for those facing hardships.

You can also roll over your employer-sponsored retirement plan into an individual retirement account (IRA) or take the money out from that account.  However, you’ll still be subject to the same early withdrawal penalty and income taxes as you would with your 401(k).  Only with a 401(k) loan will you be able to avoid both the taxes and penalties, because you’re borrowing the funds, not pulling them out permanently.

Can You Cash Out While Still Employed?

An unexpected illness or job loss can take a toll on your family finances. If you’re facing such hardship, you may have wondered, “Can I cancel my contributions to my 401(k) and cash it out while still employed?” 

Taking an early withdrawal from your retirement account should be the last resort because it comes with very high costs in terms of income taxes and penalties.  Depending on your income and marginal income tax rate, as much as one-third of the amount you withdraw will need to go to pay income taxes and penalties.

Typically, you won’t be able to completely cancel your 401(k) contributions and permanently close your 40(k) account while you’re still employed, because there are several federal employment and IRS tax rules in place that prevent this, even if it is at the employee’s request. In addition, not all employers will allow early withdrawals from their organization’s 401(k) plan. We recommend you speak with someone in the HR department of your company to understand the plan-specific withdrawal rules. If the plan administrator allows it, you may be able to take out a 401(k) loan, apply for a hardship withdrawal, or roll your account into a personal IRA account.

If you choose to cash-out your 401(k), and you’re not at least 59 ½ years old, any amount you withdraw will be subject to the ordinary income tax rate based on your tax bracket, plus a mandatory 10% early withdrawal penalty on top of that. 

If you’re withdrawing from a Roth 401(k) account however, you can withdraw up to the total amount of your contributions only, penalty and tax-free. With Roth 401(k) and Roth IRA accounts, it is assumed you withdraw your contributions and any converted contributions first, and then your earnings are assumed to be withdrawn after that.  Once you withdraw your earnings, you’ll pay taxes and penalties on that withdrawn money, the same as if you took it from your Traditional 401(k)..

3 Ways To Take Money Out of a 401(k) While Employed

If you’re wondering how to cancel and cash out your 401(k), we recommend you check with your plan provider and read your plan details to understand your options. Generally, you’ll be able to take an early withdrawal with one of these three methods.

1. Take a 401(k) Loan

A 401(k) loan is perhaps the best way to cash out your 401(k) while still employed if you think you’ll stay at your current job for at least five more years. You’ll essentially be borrowing from yourself and will be required to pay back what you borrow, with interest.  Instead of paying interest and principal to a bank, you’ll be paying back yourself.

As you would expect, there are limits to how much you can borrow.  For most 401(k) plans, you can only borrow 50% of your current balance or $50,000, whichever is less. In most cases, the loan is processed in 2-3 business days, and you’ll receive the funds in your bank account a couple of days after it’s processed.

It’s important to note that you can only take out one 401(k) loan at a time, and you must pay back your current loan before you can take out another one.  Even if your plan does allow multiple loans outstanding at a time, the maximum loan limits still apply.  You’ll need to repay the funds within five years, through monthly installments, which are usually paid back to your 401(k) account via payroll deductions. You can also make extra payments, without penalty, if you wish to pay the loan off early.  

The interest rate for 401(k) loans is usually prime rate plus 1%-2%. If you default on the loan, the IRS will view the loan amount as a withdrawal, and count it as taxable income, on which you’ll pay ordinary federal and state income tax, along with the 10% mandatory penalty if you’re under 59-½ years old. 

If you get fired or quit your job with an outstanding loan, you may be required to repay the outstanding balance within 60 days with a lump sum payment, otherwise the outstanding balance at the end of the 60 days will be considered a withdrawal.

2. Get a Hardship Withdrawal

The Internal Revenue Service (IRS) only allows 401(k) hardship withdrawals when it’s due to an immediate and heavy financial need. Also, it limits the amount you can withdraw based on your financial need. Since this benefit is, from a legal standpoint, an option that can be offered on a 401(k) plan, not all employers may offer hardship withdrawal. It’s always best to check with your plan administrator or HR department before you apply.

You may qualify for penalty-free hardship distributions in the following situations:

• Certain medical expenses
• Qualified educational expenses, including tuition and books
• Costs related to first-time purchase of a principal residence
• Costs related to the prevention of foreclosure or eviction from the primary residence
• Burial or funeral expenses of the account holder
• Costs for the repair of principal residence due to a natural disaster
• Costs related to the adoption or birth of a child
• Total and permanent disability of the account holder

Unlike loans, you don’t have to pay back hardship withdrawals. However, they’ll be included in your gross income, so you’ll have to pay taxes on the amount you withdraw.

3. Roll Money to an IRA

Another option to cash out your 401(k) while still employed is to roll over your 401(k) to a personal IRA account, where there are little to no administrative hassles to taking withdrawals as you need to. 

An IRA is still an eligible retirement account, so the IRS allows direct rollovers from 401(k) retirement accounts without income taxes or penalties, as long as the IRA is of the same tax-type as your 401(k).  This means, doing a direct rollover from a Traditional 401(k) to a Traditional IRA, or direct rollover from a Roth 401(k) to a Roth IRA.

Once you roll your money over to an IRA, distributions are still subject to the same income tax and early withdrawal penalty regulations as your 401(k) account. However, you’ll have more control over the IRA’s investment options and your ability to take withdrawals. 

You’ll be able to withdraw up to the total amount of your contributions from a Roth IRA, tax and penalty-free at any time, and for any reason. However, since it is a pre-tax account, you’ll still pay taxes and potential penalties on the money you withdraw from a Traditional IRA. The 10% withdrawal penalty may also be waived for certain exceptions, such as for higher education expenses and paying health insurance premiums while you’re between jobs.

Pros and Cons of Cashing Out 401(k) While Still Working

Here’s a quick look at the advantages and drawbacks of cashing out your 401(k) while still working.

Pros

• You’ll have immediate access to funds in case of an emergency.
• You may qualify for penalty-free withdrawals in some cases.
• You can use the money for medical expenses, to pay off debts, or as a down payment on a house or a car.
• It’s easy to get access to money without a credit check, and at a low interest rate in the case of a 401(k) loan.
• You won’t have to pay the money back, in case of a hardship withdrawal.

Cons

• You may have to pay income taxes and an early withdrawal penalty on the full amount of the withdrawal.
• Your retirement savings balance will shrink, affecting your long-term retirement goals.
• You’ll lose out on growth, dividends, and compound interest earned on the money you had invested in your 401(k).
• Any company matching contributions that have not had enough time to vest in your 401(k) account will not be available for withdrawal.
• You may have to delay retirement and/or you may not have enough funds during retirement to support yourself on your own.

Debt expert and founder and managing director of Reichert Asset Management LLC, Brad Reichert, gives his opinion on using your 401(k). “It’s worth considering taking out a personal loan or borrowing from friends and family to cover a temporary cash need,” Reichert says. He also suggests taking a withdrawal of your contributions from a Roth 401(k) or Roth IRA, which are always tax-free and penalty-free when withdrawn.  

“The optimal solution is to have an emergency reserve account with at least three months’ worth of expenses set aside to use when disruptions in your income arise,” Reichert encourages. “Being able to access a liquid source of cash immediately is always preferable to liquidating your long-term 401(k) investments that are meant to be used in your retirement years,” Reichert adds.

The Bottom Line on Cashing Out Your 401(k) While Still Employed

Your nest egg must last long enough to provide financial security during the entire 15-30 years of your retirement. This means contributing regularly and carefully managing your 401(k) investments according to your goals, your investment time horizon, and tolerance for financial risk.

While it is possible to withdraw from your retirement funds in case of an emergency, we recommend you consider all other options, such as taking out a personal loan, before choosing to do so. If there’s no other alternative available, a 401(k) loan is a better option to cover emergencies than a hardship withdrawal. However, we recommend you consult with a fully-licensed and experienced financial advisor to determine how to mitigate the potential income tax and penalties due to early distribution.