Should I cash out my 401K?Try hiring a financial adviser, reducing your living expenses and refinancing your home.
Q: I am a 49 year old who plans to retire from my current job by age 55. My 401(k) is now worth $1.1 million, which is up 20 percent since January. It is invested in several different mutual funds. I also have another $975,000 in a combination of my company’s stock and various other stocks.
My question is about the 401(k). I would like to know if it makes sense to turn all of it or half of it into cash since it the account is currently worth so much and then buy it back when the market takes a hit?
It is so tempting to try to cash in at least part of it since it took 25 years of investing to get the account to its current level. I am worried if I don’t do something, the market will take a dive and it will go back down to the $700,000 range.
I’m also wondering if when I do turn my 401(k) into cash if I should pay off my remaining home loan balance.
A: Congratulations on creating a serious level of financial security for yourself. You’ve got roughly $2 million in investable assets and hope to retire from your current company in about 6 years.
What you’re asking is whether it’s okay to try and time the market. In general, that never works. Some folks try it and get lucky (or not) and perhaps you’ll be one of the few that gets it right. Sell now, when everything is at the high (or so you think) and then buy it back when the market takes a hit. Surely, you could sell some and see what happens.
But we think you’re focusing on the wrong issue. What happens when you hit 55? Sure, you retire from your company, but the odds favor you living well into your late 80s, or another 30+ years. You’ve got years to let your $1.1 million recover, should there be a problem in the stock market and if they’re in mutual funds they’re hopefully well-diversified.
Here’s a bigger problem: You’ve got nearly half of your cash in your company stock and what sounds like a handful of other companies. That’s a far bigger risk.
While publicly traded companies can be solid investments, there’s always a possibility of an Enron, where undercover shenanigans can kill a company and its stock overnight. Or, there’s a Lehman, which traded near its all-time high within 30 days of essentially going out of business. Or, you have a great company like Microsoft or Intel, whose stock essentially stops moving even though the companies are cash cows because someone on Wall Street no longer considers them to be growth industries.
Having a great deal of your financial wealth concentrated in just a few companies is dangerous. Most financial advisors will tell you that you should limit holdings in any one company (especially your employer) to 10 percent or less of your total investable assets (excluding your home equity).
The other part of the equation is what you plan to do at 55. Will you leave the working world forever, kick back and play golf? Are you planning on traveling the world? Or, are you going to take another job or start a company?
On the home front, will your house be paid off? Will you sell it and move to someone less expensive? Will you stay and buy a vacation home in a warm-weather or recreational location?
Each of these goals will require some level of funding, and you may even require more cash if you retire early and then wind up having to pay for health insurance for 10 years until you qualify for Medicare at age 65.
You have a lot of money (which is great) and a lot of unanswered questions (at least in this email). I think you should find a great financial planner who can help you walk through various scenarios, help you explore what it will cost you to live the way you want after you retire from your current company, and then come up with an investment strategy that will get you where you want to go.
In the meantime, the smartest move you can make is to figure out how to reduce your living expenses when you’re retired, as that will increase your cash flow and give you the most options. If you haven’t refinanced your home recently, you should consider doing so. For someone with your financial strength, we’d recommend refinancing into a 10-year loan (currently available at less than 3 percent), and then focus on getting it paid off by the time you officially retire.
FAQs
It's also not a great idea to cash out your 401(k) to pay off debt or buy a car, Harding says. Early withdrawals from a 401(k) should be only for true emergencies, he says. Even if you manage to avoid the 10% penalty, you probably will still have to pay income taxes when cashing out 401(k)s.
Should I cash out my 401k in this economy? ›
Try to avoid making 401(k) withdrawals before age 59 ½, as you will incur taxes on the withdrawal (unless you have a Roth account) in addition to a 10% penalty. If you are closer to retirement, it's smart to shift your 401(k) allocations to more conservative assets like bonds and money market funds.
How much of your 401k should you take out? ›
The 4% rule is when you withdraw 4% of your retirement savings in your first year of retirement. In subsequent years, tack on an additional 2% to adjust for inflation. For example, if you have $1 million saved under this strategy, you would withdraw $40,000 during your first year in retirement.
What do I need to know before cashing out my 401k? ›
Early withdrawals from a 401(k) account can be expensive. Generally, if you take a distribution from a 401(k) before age 59½, you will likely owe: Federal income tax (taxed at your marginal tax rate). 10% penalty on the amount that you withdraw.
How do I avoid 20% tax on my 401k withdrawal? ›
Deferring Social Security payments, rolling over old 401(k)s, setting up IRAs to avoid the mandatory 20% federal income tax, and keeping your capital gains taxes low are among the best strategies for reducing taxes on your 401(k) withdrawal.
What are the issues with cashing out 401k? ›
If you have reached the age of 59½ (or 55 or 50, in certain cases), you can cash out your 401(k). But keep in mind that you have to pay taxes on whatever you withdraw. Depending on the size of your account, you could be facing a huge tax bill, especially since those funds may bump you into a higher tax bracket.
Can I lose my 401k if the market crashes? ›
The odds are the value of your retirement savings may decline if the market crashes. While this doesn't mean you should never invest, you should be patient with the market and make long-term decisions that can withstand time and market fluctuation.
Is it better to have a 401k or nothing? ›
Experts suggest saving 10-15 percent of your annual income for retirement, but again, any money going towards retirement savings is better than none at all.
What happens to my 401k if we go into a recession? ›
The value of a 401(k) account, or any retirement account, always depends on how the account is invested. For many people who are still decades away from retirement, their portfolios will largely consist of stocks, which may suffer declines during a recession or economic slowdown.
How much of my 401k should be cash? ›
A general rule of thumb is that cash and cash equivalents should comprise between 2% and 10% of your portfolio.
Summary. $300,000 can last for roughly 26 years if your average monthly spend is around $1,600. Social Security benefits help bolster your retirement income and make retiring on $300k even more accessible. It's often recommended to have 10-12 times your current income in savings by the time you retire.
Can I close my 401k and take the money? ›
The IRS allows individuals to cash out their 401k and roll it over to an IRA without penalty and without the cashed-out amount being subject to taxation. You can also close out a 401k without penalty when you leave your job if you are at least 55 years old, but taxes will apply to the amount you withdraw.
How much will I lose if I cash out my 401k? ›
Dipping into a 401(k) or 403(b) before age 59 ½ usually results in a 10% penalty. For example, taking out $20,000 will cost you $2000. Time is your money's greatest ally. But when you withdraw from your future savings, you're denying your money the chance to earn valuable interest.
At what age is 401k withdrawal tax free? ›
As a general rule, if you withdraw funds before age 59 ½, you'll trigger an IRS tax penalty of 10%. The good news is that there's a way to take your distributions a few years early without incurring this penalty. This is known as the rule of 55.
How much tax will I pay if I withdraw my 401k? ›
Participants in a traditional 401(k) plan are not allowed to withdraw their funds until they reach age 59½, with the exception of withdrawing funds to cover some hardships or life events. If you withdraw funds early from a traditional 401(k), you will be charged a 10% penalty, and the money will be treated as income.
Is it a good idea to take money out of your 401k to pay off your mortgage? ›
Depending on how big your nest egg is, paying off your mortgage with your 401(k) could make sense. However, look at your other savings or assets first. If you need to stretch your 401(k) into retirement, it may make more sense to keep it invested and use other assets to pay down your mortgage.
What are the cons of 401k withdrawal? ›
Cons: If you leave your current job, you might have to repay your loan in full in a very short time frame. But if you can't repay the loan for any reason, it's considered defaulted, and you'll owe both taxes and a 10% penalty on the outstanding balance of the loan if you're under 59½.
