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UNEMPLOYED! Should I Cash Out My 401k?

Unemployment is a scary thing in this tight job market. It’s tempting to look at that 401k plan you amassed over the years at your last employer as nice cash cushion while you get back on your feet and figure out what to do. Before you make any rash moves, though, you should carefully consider the consequences of making such a distribution:

Income Taxes
You won’t get the full balance. Your employer must withhold 20 percent of your plan balance to send to the IRS to cover income tax on the withdrawal. In addition, you will be liable to pay the remainder of any income tax due by April 15th of the year following the tax year in which you make the withdrawal.

Unless you are age 55 or older, you will also need to pay a 10 percent early distribution penalty. Worse yet, this additional 10 percent is calculated based on the entire withdrawal – not just what you receive after taxes. So you will have to pay part of that penalty on money you never receive. Note that this age is 55, not 59 ½. This provision applies to those over 55 who have left their company. If you have not left your company, the 10 percent penalty will apply until you turn age 59½.

Exceptions to the 10 Percent Rule
The IRS waives the penalty on early withdrawals from 401k plans if you execute a rollover to an IRA or other qualified retirement plan, or you are over age 55 and have left your employer. For some public safety employees, that cutoff is age 50). If you have medical bills that are more than 7.5 percent of your adjusted gross income, the IRS will also waive the penalty on enough distributions to cover the remainder of the bill. Note that you don’t have to itemize your deductions to take advantage of this provision.

If the IRS levies your retirement account, you will pay income tax (duh!) but you will be exempt from the 10 percent penalty on the withdrawal the IRS forces.

Advantages of IRAs
IRAs, or Individual Retirement Accounts, offer a similar list of hardship exceptions to the 10 percent penalty, but with two notable advantages: With IRAs, you can also make penalty free withdrawals to cover college expenses, and to purchase a home. You may not feel like purchasing a home while you’re unemployed. But if you were sitting on the fence about going back to school and you have the money, you won’t pay a penalty if you tap an IRA to do so.

IRAs also allow you to make penalty free withdrawals to avoid foreclosure or eviction. To take advantage of these provisions, though, you will have to execute a rollover to an IRA. You cannot try it from your 401k, or you will run into the 20 percent withholding and 10 percent penalty issue.

Section 72(t)
Section 72(t) allows you to avoid the 10 percent penalty by spreading your income from your 401k over the rest of your life expectancy. This can provide a nice cash cushion, though you do lose a bit of tax-deferral benefit on any amounts you take as income.

The Unemployment Trap
There is one significant trap that may affect the unemployed, however: Any withdrawals you take from a 401k plan could offset unemployment compensation. Be sure to take a careful look at your state’s plan rules before you take anything out of a 401k, or you could render yourself ineligible for unemployment compensation altogether – just when you need it most. For this reason, I would be very wary indeed of taking any 72(t) or any other withdrawal unless I did not qualify for unemployment compensation.

Rolling it over
If you do choose to roll it over, I recommend executing a trustee-to-trustee transfer. You can have the 401k plan send you a check directly, but then the clock is ticking. You have only 60 days to complete the rollover. If you screw up, you will pay taxes and penalties on the whole thing at once. Have your 401k plan send the money directly to the IRA custodian. You’ll avoid the 20 percent withholding and you won’t have to worry about slipping up.

Roth IRAs
If your income will be unusually low this year because of the job loss, it may pay to consider rolling part or your entire 401k into a Roth IRA. You pay your income taxes now, but your tax brackets might be the lowest they will be for the rest of your life. From that point, your Roth IRA grows tax free.

Final Thoughts
If you have a lot of itemized deductions, don’t sweat the income taxes on small withdrawals. The penalty is bad, but if you can avoid the 10 percent penalty, and then take a taxable withdrawal to pay for an expense that’s tax deductible – like educational expenses directly related to your profession, or job search expenses – then you really have a wash.

…or find your next job in our CAREER section!

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18 Responses to UNEMPLOYED! Should I Cash Out My 401k?

  1. Pingback: UNEMPLOYED! Should I Cash Out My 401k? | View Vitaver … | Free Job Search Info

  2. Richard Jensen says:

    Before cashing out, consider a “self-loan”. This is a short summary. Also check with your financial advisor.

  3. Loraine Heller says:

    Cashing in a 401k is tempting, but according to experts, should be avoided at all costs. It has penalties associated with it that can cost you a bundle in money, time, and nerves. Find some financial advice, either at your bank or from an independent financial adviser. Don’t make a move on your 401k until you’ve gotten expert advice.

  4. 401k plan says:

    I really like this post. It is sharing good information.

  5. marguerite seigler says:

    reallocate some to investment and some to survival.

  6. Tim Blackwell says:

    I’m 57 and my wife has cancer and been fighting it for 3 years and costs a lot in co-pays gas to another hospital. We were told by our company that I work for that a lot of people will be in a permant lay off and I believe I will be one of them. So no insurance or income except my wife’s disabilaty check and I owe $6,000.00 on a loan from to my 401k or 501k which they take payments out of my paycheck everyweek and right now we are having to pay some bills with a credit card to get by. So starting Jan next year I may have nothing but a car, truck and house that’s paid for but will have big bills for my wife’s cancer treatments that are high and will be hard for me to get another job no where close to what I make now and the benefits. I need case so what do I have to do to get my saving from the 401k to keep my wife going to get treatments and to cover our monthly bills?

  7. Hello, Tim, and thanks for writing!

    Very sorry to hear your wife has been battling cancer. I certainly wish you the best.
    This situation is very fact-dependent, for your individual situation, so I would have to say go speak with a qualified financial planner, preferably with a CFP or the lesser-known but excellent ChFC (Chartered Financial Consultant) designation, preferably someone with some experience with 401(k)s for the specifics.

    But in terms of general information, here are some issues for you to be aware of – and maybe they’ll help you avoid the nastier penalties.

    First of all, hardship withdrawal provisions with 401(k)s vary. If you were all in an IRA, it’s pretty clear that you can take penalty-free withdrawals to pay for medical expenses exceeding 7.5 percent of your income and to pay health insurance premiums, among other hardships. Not every 401(k) allows for it, though. It depends on your plan, so you’ll have to check with your plan administrator.

    If you are about to leave the company, though, you can access your plan assets without the 10 percent penalty anyway, provided you have left the service of the company, since you are over 55. 401(k) rules allow you to make withdrawals without the early withdrawal penalty once you turn 55, provided you’ve left the company.

    If you haven’t left the company yet, you can roll over to an IRA, but only if the plan allows for in-service distributions. Not all 401k plans do, so check with your plan administrator.

    You still have the loan outstanding, but that’s not a huge deal, since you’re trying to pull money out anyway. If you don’t pay back the loan, it gets treated as the distribution you were going to take anyway.

    There are so many variables here that depend on your plan and on the other assets you may have that it would be worth going to a local professional planner for advice for your specific situation, though.
    There’s some additional work to be done in making sure health insurance coverage continues after you’ve left the company. How you do so depends on your state. Some states let you convert your group policy to an individual one. In other cases, your only option is COBRA. And then things change again with the Affordable Health Care Act, but not until 2014, and only if the next Congress doesn’t repeal the law.

    I wish you the best, and a speedy recovery for your wife.


  8. Tim Blackwell says:

    Thank you Jason for your help…..

  9. Lisa says:

    I quit my job. I only have $100 in my former companies 401K. I am still unemployed after a month and could really use the cash. Is there a penalty and IRS taxes for such a small sum withdrawal?
    I thought I heard that if the amount was less than $499.00 there is no taxes.

  10. Justin says:

    I want to cash in my 401 k and my boss told me no only when I die I could get it I work at a hostile job I don’t think I can work at this place much longer the verbal abuse and there is no human resource he runs it all and I can’t get a honest answer I got paper work but no bank about my 401 k?? Help

  11. Hello, Justin! And thanks for reading!

    If you leave your employer, and it is, indeed, a 401(k), you can roll your plan over to an IRA and access it that way. If your employer objects, I would introduce him to the enforcers at the Department of Labor.

    If you don’t leave your employer, he has a perfect right to restrict your access to the 401(k). Different companies design their plans different ways, and some specifically choose not to allow for ‘in-service distributions.’

    If you are in a non-qualified deferred compensation plan, though, there could be some strings on it. Or you could be in a life insurance policy. So I’d want to be very sure of your terms before going off half-cocked. Make sure it’s a 401(k) you’re in.

    It’s rare, but it’s also possible that your employer is not depositing your contributions but keeping them for himself. would be a very big deal and potentially expose your employer to some serious jail time.

  12. Gerry Cardnot says:

    Hi. If I have a loan and quit my job, I now know I have 90 days to pay it back? If I decided to cash out the rest of the money only for 45 days and then put it back in another 401k account, do I need to pay taxes still? Is there a time frame so it doesn’t become taxable?


  13. Hello, Gerry,

    I’m not a tax expert, but I wouldn’t push it. I would suggest paying back THAT 401(k) that you took the loan from. I don’t know if the IRS will charge you taxes if you contribute that money to a diffferent plan, but why take the chance? If you contribute the money to a new plan, you would use up part of of your contribution limit for the year. Maybe all of it. Why do that, when you can simply pay off the loan, and then, now that you’ve left the company, roll the money over to an IRA or to your new employer-sponsored plan.

  14. Rachel thomas says:

    I got fired from my job in July, now I am having a hard time paying bills, buying food things I really need. I want to pull out my 401k but I owe the irs will they take all of the money I need from my 401k

  15. Jatin Shah says:


    I was laid off Dec 2012 last year. I haven’t been lucky enough to find a job as I am on immigrant visa. Due to hard times, I withdrew approx. 10K from my 401k. Needless to say they withheld 20% and gave me 8k. While I not asking if I made the right decision, I feel that was the only option I had to keep my family going. I have left the country now in June 2013. Do I still file tax returns, and if so do I show just the income from 401k? If I file taxes, do I get head of household and personal exemption (with 1 dependents)?
    I would really appreciate good advise.

  16. Tony says:

    Well this may sound like double trouble. I’m 42 and recently diagnosed with congestive heart failure. I have been in and out of the hospital several times and have racked up some serious bills. I collected an insurance policy from my late mother $20,000 last year and paid $15,000 to cover less than half of my medical bills. I had to quit my job and was on SDI. I lost my insurance 3 months later so I no longer collect. I owed the State (CA) back pay from 2010 for over payment for unemployment insurance ( yes I should have paid them off first) the SDI went straight back to the state for collections.I currently owe EDD $5,000. I wanna cash out my 401k with only $2600. Is there anything I can do to collect my money without the state collecting all of it. I understand I made a huge mistake with EDD but I have no income and looking for full time work in a new career field or if must go back to school. I need advice please I’m in a bad spot and want out! thank you

  17. Hello, Tony! Neither I nor Vitaver give tax or legal advice, but here are a few issues to look at given your situation. You should run these by a professional licensed in your area.

    First, if your money’s in a 401(k) the State can’t touch it. It’s in a noncollectable account with pretty close to airtight asset protection. Even the IRS has a hard time cracking open 401(k) accounts. The most they can normally do is get a charging order against income. Your 401(k) balance is in an ERISA protected plan. It’s not even your money. It’s held in trust for you. Which is what makes it so difficult for even governments to collect money WHILE STILL IN A 401(K) plan.

    But the second the funds are released, they are fair game for government collectors.

    Is there a charging order in place already? That means the state has obtained a court order to divert income released to you to them instead, but they can’t force the 401(k) to release funds.

    If there IS a charging order in place, then the state can, in fact, intercept the funds, but only if you have them distributed.

    You might be able to make a deal with the CA Department of Revenue and get them to remove the charging order as part of that deal. How do you go about that? Make sure all your returns are current, and contact the California Franchise Tax Board. Here’s the form you’ll eventually have to fill out, with more information on it.

    You could also speak with an attorney about filing for bankruptcy, which would halt collections for a time. However, there are potential downsides to this course of action depending on your overall situation, including the assets you have, exemptions, whether you qualify for Chapter 7, etc.

    Next, check any hardship provisions in the 401k plan. Not all 401k plans allow for hardship distributions You may be better off rolling your balance over to an IRA first. This way, you get around the 20 percent withholding requirement. The 10 percent penalty for early distribution doesn’t apply for either 401ks or IRAs if you are completely and totally disabled. You’ll still owe income taxes but your income seems pretty low if you’re living on SDI, so the income taxes shouldn’t amount to much.

    Hope that helps!


  18. Patricia says:

    I am about to be terminated, fired. I have a Roth 401K that I have had for 3 yrs. I may need the money to live on. I do not have another job. What is my best option? Are there penalties for early withdraw on a ROTH 401K? What would you advise?

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