Are you considering cashing out your 401k plan early due to debt or other financial hardships? You can end up losing 30% of your money. If you want to pull out your money without paying a 401k withdrawal penalty, this video is going to show you the best way to do just that.

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Consequences of a 401k Early Withdrawal or Cashing Out a 401k

The IRS generally requires automatic withholding of 20% of a 401k early withdrawal for taxes. So if you withdraw $10,000 from your 401k at age 45, you may get only about $8,000. You’ll get hit with a 401k withdrawal tax.

Along with the withholding taxes, the IRS will also hit you with a 401k withdrawal tax. If you withdraw money from your 401k, the IRS takes a 10% penalty when you file your tax return.

This means that you’re going to lose 30% of the amount that withdraws early from your 401k.

Retire with less.

You have to balance the long term effects of cashing out your retirement accounts. That may be ESPECIALLY true if the market is down when you make the early withdrawal. So, if you pull your money out, you’re losing out on the gains that your 401k would have if you had just waited 1-2 years for the markets to improve.

How long does it take to cash out a 401(k) after leaving a job?

It can take up to 10 business days to receive a check after cashing out your 401k. But this does not mean 10 days from when you inform Fidelity 401k that you want to cash out your 401k. This means after your 401k account manager sells your interests in your investments, it will take up to 10 days to get your check.

This means it could take 2-3 weeks to get your money from your 401k.

10% Tax Penalty Exemption

There’re a few reasons why the IRS would allow you to be exempt from the 401k withdrawal tax penalties.

Substantially equal periodic” payment plan

With this plan, retirement plans can be cashed out penalty-free. But this is only if you take annual distributions for a period of five years or until you turn 59½. But income tax must still be paid on the withdrawals.

You leave your job

This works only if it happens in the year you turn 55 or older.

Getting a Divorce

When you get divorced, you may be pulling money out of your 401k to give to your spouse. If this happens, then you won’t be charged a penalty for taking money out of 401k.

See if you qualify for a hardship withdrawal

A hardship withdrawal is a withdrawal of funds from a retirement plan due to “an immediate and heavy financial need.” A hardship withdrawal usually isn't subject to penalty. 401k hardship rules allow us to make penalty-free hardship withdrawals.

How to make a hardship withdrawal

The retirement account manager that oversees your employer’s 401ks is the one who decides if you qualify for a hardship distribution for your 401k. You may need to explain why you can’t get the money elsewhere, such as a loan or savings account.

Consider converting your 401(k) to a ROTH IRA

Individual retirement accounts have slightly different withdrawal rules from 401ks. So, you might be able to avoid that 10% 401k early withdrawal penalty by converting your 401k to a Roth IRA first. There are no mandatory withholding on IRA withdrawals.

That means you might be able to choose to have no income tax withheld and thus get a bigger check now. You still have to pay the tax when you file your return, though. So you’re never off the hook from the IRS.

To take advantage of this tax-free withdrawal, the money must have been deposited in the Roth IRA and held for at least five years AND you must be at least 59½ years old.

So, you can’t just roll your 401k into a Roth IRA today and pull it out tax-free tomorrow.

The other way is by pulling money out of your Roth IRA and paying for college.

Withdrawals for college expenses could be OK if they fit the IRS’s definition of “qualified higher education expenses.” Qualified expenses are amounts paid for tuition, fees, and other related expenses for an eligible student.

And truthfully, this one probably won’t even affect you unless you’re a little bit older and you decided to go back to school.

4. Take out the bare minimum when cashing out a 401(k)

This means if you absolutely need $10k for an emergency, don’t pull out $15k just in case you need extra.