Should you cash out a 401(k)?
In most circ*mstances, a financial advisor will suggest it’s best to avoid cashing out your 401(k). If you do, you’ll be on the hook for taxes and/or penalties, and you’ll severely cut into the growth potential of a valuable tax-deferred retirement account.
However, if you do find yourself up against an immediate and emergent expense (usually known as hardship withdrawals), you always have the option of cashing out early to regain access to your money. There are some nuances to hardship distribution penalties, which can include events ranging from medical expenses and medical bills, funeral expenses, foreclosure prevention, or heavy financial needs, so it’s important to discuss with your financial advisor before you make any financial decisions. While it’s not the financially optimal decision, it may be the necessary one should you find yourself in any one of these positions.
Again, cashing out your 401(k) is not the same as rolling over your 401(k) account balance, which is, in many cases, a good idea. In fact, a forgotten 401(k) can have a seriously detrimental effect on your retirement savings (i.e., it can add years to your working career). Be sure to know the location of each retirement account you own and take active steps to optimize their respective positions.
Alternatives to cashing out a 401(k)
Cashing out a 401(k) comes with many disadvantages, so if you need emergency access to money, you may want to consider one of these alternatives.
Consider a 401(k) loan.
If you haven’t yet left your job, a 401(k) loan may be an option. Similar to cashing out your 401(k), a 401(k) loan against your retirement fund can get you access to the money you need, but it keeps your account open, and technically, you’re paying yourself back for the loan. However, you’ll need to be cautious with 401(k) loans. If you leave your company, you could be on the hook for paying back the balance due within 60 days, and failure to do so could mean a hefty tax burden.
Assess other low-interest loan options.
There are many low-interest loan options available, whether it’s an unsecured personal loan, a balance transfer credit card, or a home equity loan. In an emergency, it can be tempting to act quickly, but you’ll need to carefully consider options before taking on loan debt. If you have a great credit score or are willing to put up collateral to secure the loan, you could receive a favorable interest rate. Before taking out any loan, many personal finance experts recommend to be sure you have a plan in place to repay the money you owe.
Increase your income.
This one is easy to say but harder to put into practice. Yet if you’re in a financial situation where you’re considering cashing out your 401(k) retirement funds, you may be willing to put in the time to earn a bit of extra money. If you have the opportunity to sign up for overtime at work, that’s a great way to earn more at a rate that might be higher than what you typically earn. Outside of full-time employment, you can explore various side hustles or gig work, whether online or in person.
Conclusion
Cashing out a 401(k) can be a serious financial decision to make. It’s important to understand how you may be impacted by taxes and penalties, so be sure to speak to a trusted personal financial advisor before you make up your mind. They may be able to help you understand your specific applicability for a hardship withdrawal, and in turn, help you avoid a costly mistake.
As an alternative, a 401(k) rollover can be a better option for your retirement savings if you want to continue your retirement strategy momentum and take advantage of compounding interest. Capitalize can help you locate old 401(k)s and choose an IRA to consolidate them into – all while managing the entire 401(k) rollover process for you, for free.
