How to cash out a 401(k): Early and hardship withdrawals

401(k) early withdrawal penalty

401(k) plans are specifically designed to allow tax-advantaged savings for retirement. To maintain this intent, strict withdrawal rules, age restrictions, and penalties have been put in place. Withdrawals that don’t meet the age requirement are subject to a 10% early withdrawal penalty and are taxed as regular income. Depending on where you live, you may also be subject to state taxes.

Aside from the early withdrawal penalty, it’s important to consider the other costs of taking money out of a 401(k) early. Long-term savings may be affected, because the money will not continue to grow tax-deferred and it won’t earn the compound interest it could have if left in the account until retirement age. Speaking with a financial professional can help you evaluate your options and make a plan for your financial future.

Related: The 4% rule for retirement

At what age can you withdraw from a 401(k) without penalty?

Generally, you can withdraw from your 401(k) at age 59½ without penalty. The rule of 55 provides an exception to this age requirement. It allows you to withdraw funds from your 401(k) as early as age 55—if you leave your job at 55 (or older) and take your 401(k) distribution during that year.

401(k) hardship withdrawal: What is it?

Retirement accounts are designed to encourage long-term investment and help individuals save for the future. Tax-deferred growth and early withdrawal penalties are strong incentives to help investors stay on track and keep their money invested for the long run. However, it is possible to access the money in a 401(k) account before retirement. A hardship withdrawal allows you to access money in your 401(k) before retirement and without penalty.

What qualifies for a hardship withdrawal from a 401(k)?

The IRS hardship withdrawal exception allows early withdrawal without penalty based on two criteria:

1. The withdrawal is needed to address an immediate and heavy financial need.
2. The withdrawal is limited to the amount necessary to satisfy that financial need.

Circumstances that satisfy a hardship withdrawal include:

• Medical expenses
• Pending foreclosure or eviction
• Tuition payments
• Funeral expenses
• Repairs on a primary residence
• Expenses related to a federal declaration of disaster

While a hardship withdrawal is not subject to the early withdrawal penalty, income and state taxes may apply.

Reasons to consider a 401(k) early or hardship withdrawal

When deciding whether to make an early 401(k) withdrawal, one should weigh the balance between short-term needs and long-term security. Using your retirement account now may affect your financial stability during retirement. Some common reasons people consider 401(k) early withdrawals include:

An immediate need for cash with no other liquidity

Prolonged unemployment, lack of an emergency fund, and not being able to qualify for conventional loans are some of the reasons individuals turn to early 401(k) withdrawals when cash is needed urgently.

Paying off high-interest debt

Funds from an early withdrawal can be used to stop or ease the financial drain caused by high-interest debt from credit cards, medical loans, and payday loans.

Avoiding financial ruin

Bankruptcy, home foreclosure, car repossession, tax liens, and lawsuit judgments are examples of situations where the inability to access cash can cause detrimental long-term effects to financial well-being.

Major life transitions

Major life events such as a cross-country move, adopting a child, starting a new business, divorce settlements, or family obligations may require access to large amounts of money that you don’t otherwise have.

Although an early withdrawal from a 401(k) is an interest-free way to access cash, it’s generally used as a last resort. In addition to taxes and penalties, early withdrawal can disrupt your retirement preparations. If a 401(k) is your only option for accessing cash, you may want to consider borrowing against your 401(k) instead of making a withdrawal to help you safeguard your retirement plans.

How to withdraw money from a 401(k) before retirement

Withdrawing money from a 401(k) takes the form of either a standard early withdrawal or a hardship withdrawal. The general steps you’ll need to take include:

1. Find out if early withdrawal is possible: Although the IRS makes provisions for hardship withdrawals, 401(k) plans are not required to allow them. Contact your Human Resources department or the 401(k) administrator of your plan to find out what is allowed.
2. Prepare a formal request: Fill out the required applications and paperwork. If making a hardship withdrawal, you’ll have to document your hardship along with the associated expenses and submit them for approval.
3. Confirm the taxes and penalties: A hardship withdrawal may still be subject to the 10% tax penalty unless it meets the IRS standards.
4. Submit the paperwork: Submit the application along with any supporting documentation and indicate the form of payment if choices are available (usually check or direct deposit).

The amount of time it takes to receive the withdrawal varies based on the institution’s processing speed and the form of distribution. A direct deposit or ACH transfer usually takes about 2-3 days, and a check may take approximately 7-10 days. Hardship withdrawals may take longer because of the verification process.

Calculating taxes on a 401(k) withdrawal

Withdrawals from your 401(k) are taxed at your regular income tax rate. For instance, if you withdraw $20,000 from your retirement account and your tax bracket is 22%, you will owe $4,400 in taxes on the distribution ($20,000 x 22%). Depending on where you live, you may also have to pay state taxes on the amount.

If you make an early withdrawal without meeting the hardship exception, you’ll owe an additional $2,000 ($20,000 x 10%) on the disbursed funds. In reality, you only have access to $13,600 ($20,000 — ($4,400 + $2,000)) with 32% going toward taxes and penalties (not including any applicable state taxes).

While it may be possible to access the funds in your 401(k) early, considering the full cost and long-term effects is crucial to making a sound financial decision.

401(k) early and hardship withdrawal FAQs

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Neither New York Life Insurance Company nor its Agents provide personal tax advice. Please consult with your tax adviser to find out whether the general concepts in this article apply to your personal circumstances.