Cashing Out Your 401(k): The Pros And The Cons

The purpose of a 401(k) plan is to help you save for retirement. When you participate in the plan, you may be able to take out a loan against your 401(k) account balance, but you might not be able to take a withdrawal.

Hardship

Some plans will allow you to take out the money that you contributed in the event of a true hardship, such as high medical bills due to a serious illness in the family. These withdrawals will generally be subject to both income tax and a 10 percent tax penalty (for participants under age 59 1/2), so they need to be used as a last resort in a serious emergency.

Leaving Your Job

When you leave your job, you can take your 401(k) balance with you. That’s a major benefit! If you roll over your 401(k) balance into an IRA or your new employer’s retirement plan, your money will continue to grow for retirement.

That big lump sum that you receive when you leave your job may be tempting. You could just take the money and spend it on whatever you like instead of rolling it over.

That's not financially responsible, though, as you will generally have to pay income taxes on the funds withdrawn as well as a 10 percent penalty tax unless you are age 59½ or older. That makes the withdrawal very expensive. For example, if you are leaving your job to go back to school or to start a business and can find a student loan or a small business loan with a low interest rate, you may be better off borrowing the money. Then, you can keep your retirement fund safe for retirement.

Tax Considerations

You don't face the tax penalty for an early withdrawal if you take your 401(k) distribution after you turn age 59½. If you do not have a Roth 401(k), you will have to pay taxes on the amount withdrawn, and you will need to take required minimum distributions beginning at age 70½. 

Neither State Farm nor its agents provide tax or legal advice. Please consult your own adviser regarding your particular circumstances.