You can make a 401(k) withdrawal in a lump sum, but is it a good idea to do so? Usually, the answer to that is no. Tax-deferred retirement plans, such as 401(k)s, are designed to provide income during retirement.
In most cases, if you make any withdrawal and are younger than 59½, you'll pay a 10% early withdrawal penalty in addition to income taxes on the amount you withdraw. Note that this early withdrawal penalty was not in effect for withdrawals of $100,000 or less in 2020 if you had been affected by the COVID-19 pandemic.
Here are some of the options available to withdraw a lump sum from your 401(k) and what you need to consider.
Key Takeaways
- You can make a 401(k) withdrawal in a lump sum, but in most cases, if you do and are younger than 59½, you'll pay a 10% early withdrawal penalty in addition to taxes.
- There were special allowances for withdrawals in 2020 for those affected by the COVID-19 pandemic.
- You can take a 401(k) loan against your balance but will be subject to penalties if you default. Those rules were also modified in 2020.
- A hardship withdrawal can give you retirement funds penalty-free, but only for specific qualified expenses and you’ll still owe taxes.
- You are limited to the lump-sum withdrawal options your plan allows.
Lump-Sum Withdrawal Options While Employed
Some companies automatically enroll eligible workers in a 401(k)—they can opt-out—while others let employees choose if and when they participate. Employers often rely on a plan sponsor to educate employees on the investments, benefits, and contribution limits of a 401(k) plan.
The majority provide sufficient direction to employees when they begin contributing to the plan, but they often fall short of providing useful information when employees change jobs, retire, or need to withdraw money from their plans.
If you currently work for an employer with an active 401(k) plan, you are limited to the lump-sum withdrawal options indicated in the original plan document. This generally means that, while you may access a portion of it, you cannot simply cash it out. The two most common lump-sum withdrawal provisions come in the form of a hardship withdrawal or a loan against your 401(k) balance.
Hardship Withdrawals
A hardship withdrawal is a lump-sum withdrawal based on financial need that you do not need to repay. A hardship withdrawal must meet the plan's criteria, such as covering crippling medical expenses, to avoid paying the 10% early withdrawal penalty. You'll still owe income taxes on the amount withdrawn.
On March 27, 2020, President Trump signed a $2 trillion coronavirus emergency relief bill, called the CARES Act, into law. It allowed those affected by the coronavirus pandemic in 2020 to take a distribution of $100,000 or less without the 10% penalty those younger than 59½ normally owe.
Account owners also have three years to pay the tax owed on withdrawals, instead of owing it in the current year. Or, they can repay the withdrawal during that period to a 401(k) or IRA plan and avoid owing any tax—even if the amount exceeds the annual contribution limit for that type of account.
There is another case where plan holders can make a lump-sum withdrawal from their plans without incurring the 10% penalty. According to Section 113 of the Setting Every Community Up for Retirement Enhancement (SECURE) Act—signed into law in December 2019—new parents are allowed to withdraw a maximum of $5,000 from their plans penalty-free to pay for adoption or birth expenses.
401(k) Loans
A 401(k) loan is typically paid back through paycheck deferrals over time. Except under the 2020 law, the loan is capped at a certain percentage of your total 401(k) balance; the IRS allows up to 50% and a maximum of $50,000 of vested funds, whichever is less.
If you have a 401(k) plan with the ability to take out a loan, you can withdraw the funds tax-free. Of course, you will have to pay them back, but this allows you to borrow from your 401(k) account and pay yourself back the interest and principal over time.
The CARES Act doubled the amount of 401(k) money available as a loan to $100,000 in 2020, but only if you had been impacted by the COVID-19 pandemic.
Options When You Leave an Employer
Lump-sum withdrawal options are not as limited when you leave an employer for another job or if you retire. You can take a penalty-free lump-sum distribution from a previous employer’s 401(k) plan up to the total vested account balance. After placing a distribution request, the plan sponsor or custodian sends a check directly to you, and the account is closed with the custodian.
If you have a Roth 401(k) balance, no taxes are withheld—with traditional pre-tax traditional 401(k) plans, sponsors withhold taxes from the balance before cutting the check. In either case, if you are under 59½, you are subject to a 10% tax penalty.
You can avoid taxes and penalties by rolling over the lump-sum withdrawal into an individual retirement account (IRA). In this case, the check is made out to the custodian of the IRA, not to you—although it should be marked “for the benefit of” you. As you never received the funds in cash, you are not taxed.
If you're switching jobs, another option is to roll over the 401(k) into the 401(k) at your new employer, if that new plan allows for this option. Review all your choices carefully before you decide.
Funds withdrawn from your 401(k) must be rolled over to another retirement account within 60 days to avoid taxes and penalties.
Special Considerations for Withdrawals
The greatest benefit of taking a lump-sum distribution from your 401(k) plan—either at retirement or upon leaving an employer—is the ability to access all of your retirement savings at once. The money is not restricted, which means you can use it as you see fit. You can even reinvest it in a broader range of investments than those offered within the 401(k).
Since contributions to a 401(k) are tax-deferred, investment growth is not subject to capital gains tax each year. Once a lump-sum distribution is made, however, you lose the ability to earn on a tax-deferred basis, which could lead to lower investment returns over time.
Tax withholding on pre-tax 401(k) balances may not be enough to cover your total tax liability in the year when you receive your distribution, depending on your income tax bracket. Unless you can minimize taxes on 401(k) withdrawals, a large tax bill further eats away at the lump sum you receive.
Finally, having access to your full account balance all at once presents a much greater temptation to spend. Failure in the self-control department could mean less money in retirement. You are better off avoiding temptation in the first place by having the funds directly deposited in an IRA or your new employer's 401(k) if that is permitted.
How Much Will I Get If I Cash Out My 401(k)?
If you cash out the entirety of your 401(k) you will get whatever is left over after taxes (and penalties if you are younger than age 59.5). So, if you were 60 years old and had $1,000,000 in your 401(k), and you were in the 25% tax bracket, you would receive $750,000. If you were, say age 50 and in the same tax bracket, you would be subject to an additional $100,000 early withdrawal penalty, leaving you with $650,000.
What Counts As a Hardship Withdrawal?
Hardship withdrawals can allow you to take out 401(k) money without paying the 10% early withdrawal penalty (but you'll still owe the deferred tax liability). Qualified reasons include certain medical expenses, qualified education expenses, the birth or adoption of a child, purchasing a first home, funeral expenses, and permanent disability.
Can I Take My 401(k) in Installments?
Yes. In retirement, you can withdraw only as much as you need to live, and allow the rest to remain invested. You can also choose to use your 401(k) funds to purchase an annuity that will pay out guaranteed lifetime income.
FAQs
A company can deny a 401k withdrawal request, especially if the funds are unvested. A 401k plan includes several requirements that must be met to access your money legally. If the employer suspects violating these rules, they may deny the withdrawal request.
What is the best way to withdraw from 401k? ›
The most common way is to take out a loan from the account. This is usually the easiest and quickest way to access your funds. Another option is to roll over the account into an IRA. This can be a good choice if you want to keep the money invested for growth.
How do I close my 401k and get my money? ›
Technically, yes: After you've left your employer, you can ask your plan administrator for a cash withdrawal from your old 401(k). They'll close your account and mail you a check. But you should rarely—if ever—do this until you're at least 59 ½ years old!
What is one disadvantage to taking a lump-sum distribution from your 401 K when you retire? ›
Lump-sum distribution
There are two key downsides: you forfeit the benefits of tax-deferred compounding by cashing out all at once; and you'll have to pay income taxes on your distribution for the tax year in which you take it, which can be a big bite out of your nest egg all at once.
How long can a company hold your 401k after you leave? ›
If you have less than $5,000 contributed, however, the old employer can only hold that account for 60 days after you leave. Then, it has to be rolled over into a new qualified retirement account.
What happens if I cash out my 401k? ›
If you withdraw funds early from a traditional 401(k), you will be charged a 10% penalty. You will also need to pay income tax on the amount you withdraw, since pretax dollars were used to fund the account. In short, if you withdraw retirement funds early, the money will be treated as income.
Can I transfer my 401k to my checking account? ›
Once you have attained 59 ½, you can transfer funds from a 401(k) to your bank account without paying the 10% penalty. However, you must still pay income on the withdrawn amount. If you have already retired, you can elect to receive monthly or periodic transfers to your bank account to help pay your living costs.
What are the negatives of withdrawing from 401k? ›
You could trigger a higher tax bill. You may have to pay a penalty. Your request might be denied. The withdrawn funds won't earn interest.
Should I move all my 401k to cash? ›
Try to avoid making 401(k) withdrawals early, as you will incur taxes on the withdrawal in addition to a 10% penalty. If you are closer to retirement, it is smart to shift your 401(k) allocations to more conservative assets like bonds and money market funds.
Can I completely cash out my 401k? ›
Yes, you can withdraw money from your 401(k) before age 59½. However, early withdrawals often come with hefty penalties and tax consequences. If you find yourself needing to tap into your retirement funds early, here are rules to be aware of and options to consider.
The easiest way to borrow from your 401(k) without owing any taxes is to roll over the funds into a new retirement account. You may do this when, for instance, you leave a job and are moving funds from your former employer's 401(k) plan into one sponsored by your new employer.
How much will it cost me to close out my 401k? ›
If you withdraw money from your 401(k) account before age 59 1/2, you will need to pay a 10% early withdrawal penalty, in addition to income tax, on the distribution. For someone in the 24% tax bracket, a $5,000 early 401(k) withdrawal will cost $1,700 in taxes and penalties.
When I retire can I take my 401k in a lump-sum? ›
Yes. In retirement, you can withdraw only as much as you need to live, and allow the rest to remain invested.
Is it better to take lump-sum or monthly payments on 401k? ›
A monthly pension payment gives you a fixed amount every month over your whole life, so you don't have to worry about changes in the stock market. In contrast, a lump-sum payout can give you the flexibility of choosing where to invest or save your money, and when and how much to withdraw.
How much tax do I pay on a lump-sum 401k withdrawal? ›
Mandatory income tax withholding of 20% applies to most taxable distributions paid directly to you in a lump sum from employer retirement plans even if you plan to roll over the taxable amount within 60 days.
Is it smart to withdraw from 401k to pay off debt? ›
While using your 401(k) to pay down debt is possible, it's often not the best financial move you can make. That's because 401(k) withdrawals often come with taxes and penalties that can eat up a third of your loan amount.
How long do you have to move your 401k after leaving a job? ›
You have 60 days to re-deposit your funds into a new retirement account after it's been released from your old plan. If this does not occur, you can be hit with tax liabilities and penalties.
How much should you withdraw from 401k annually? ›
One frequently used rule of thumb for retirement spending is known as the 4% rule. It's relatively simple: You add up all of your investments, and withdraw 4% of that total during your first year of retirement.
Do 401k Withdrawals reduce Social Security? ›
Will withdrawals from my individual retirement account affect my Social Security benefits? Social Security does not count pension payments, annuities, or the interest or dividends from your savings and investments as earnings. They do not lower your Social Security retirement benefits.
Do you always have to pay taxes on a 401k withdrawal? ›
Traditional 401(k) withdrawals are taxed at an individual's current income tax rate. In general, Roth 401(k) withdrawals are not taxable provided the account was opened at least five years ago and the account owner is age 59½ or older. Employer matching contributions to a Roth 401(k) are subject to income tax.
A 401(k) rollover is much better in the long-term than a 401(k) withdrawal. With a withdrawal you'll pay taxes and penalties if you're under 59 ½ years old. And your money will stop growing. A rollover of your 401(k) into an IRA is tax-free, and doesn't have to take long.
Where should I put my 401k money right now? ›
Some of the options are:
- Sell it and use the money for other purposes.
- Take out what you need for retirement in cash without paying any penalties.
- Roll it over into an IRA or Roth IRA.
- Pay off debts with the money.
- Invest in stocks or other investments.
Your 401(k) will make money or lose money based on the strength of the stocks and mutual funds in which you invest. Your balance is likely to drop when the market drops, depending on what funds you've chosen. Since investments are not insured by the Federal Deposit Insurance Corp.
What are the 3 states that don't tax retirement income? ›
Fortunately, there are some states that don't charge taxes on retirement income of any kind: Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming.
How do I cash out my 401k with the least amount of taxes? ›
One of the easiest ways to lower the amount of taxes you have to pay on 401(k) withdrawals is to convert to a Roth IRA or Roth 401(k). Withdrawals from Roth accounts are not taxed. Some methods allow you to save on taxes but also require you to take out more from your 401(k) than you actually need.
How do I convert my 401k to tax free? ›
If you decide to roll over your entire 401(k) balance, you can roll all of your pre-tax dollars into a traditional IRA and all of your nondeductible contributions into a Roth IRA. You wouldn't pay taxes on this type of conversion because you already paid taxes on your nondeductible contributions the year you made them.
Who approves 401k withdrawal? ›
The 401(k) plan administrator is responsible for approving 401(k) loans. Once you send your loan application, the plan administrator must review the application to determine if you qualify to borrow against your retirement savings.
Does your employer have to approve hardship withdrawal? ›
But before you prepare to tap your retirement savings in this way, check that you're allowed to do so. Employers don't have to offer hardship withdrawals, or the two other ways to get money from your 401(k)—loans and non-hardship in-service withdrawals.
Can I withdraw from my 401k while still employed? ›
Withdrawing vs cashing out your 401(k)
You can do a 401(k) withdrawal while you're still employed at the company that sponsors your 401(k), but you can only cash out your 401(k) from previous employers. Learn what do with your 401(k) after changing jobs.
Who do I contact to cash out my 401k? ›
You'll simply need to contact your plan administrator or log into your account online and request a withdrawal.
To make a 401(k) hardship withdrawal, you will need to contact your employer and plan administrator and request the withdrawal. The administrator will likely require you to provide evidence of the hardship, such as medical bills or a notice of eviction.
What qualifies as a hardship for 401k withdrawal? ›
Hardship withdrawals can be made for “immediate and heavy” financial need, according to the Internal Revenue Service, to pay for things like medical bills, a down payment for a new home, college tuition, rent or mortgage to prevent eviction or foreclosure, funeral expenses and certain home repairs.
Can IRS intercept 401k withdrawal? ›
401(k) plans are governed by a federal law known as ERISA (Employee Retirement Income Security Act of 1974). Assets in plans that fall under ERISA are protected from creditors. One exception is federal tax liens; the IRS can attach your 401(k) assets if you fail to pay taxes owed.
Can you lose your 401k if you get fired? ›
If you've been let go or laid off, or even if you're worried about it, you might be wondering what to do with your 401k after leaving your job. The good news is that your 401k money is yours, and you can take it with you when you leave your old employer.
What tax rate do you pay on 401k withdrawals? ›
However, if you make a withdrawal before reaching 59 ½, you will pay income taxes on any interests and gains on your retirement savings, and a 10% early withdrawal tax, unless you need the money due to disability or death.
How many hardship withdrawals are allowed in a year? ›
You can receive no more than two hardship distributions during a plan year (calendar year for all Guideline 401(k) plans). The amount requested may not be more than the amount needed to relieve your financial need, but can include any amounts necessary to pay taxes or penalties reasonably anticipated.
When can you withdraw from 401k tax free? ›
So, if you want to avoid paying the penalty, you need to wait until you are at least 59 ½ years old before you start withdrawing money from your 401(k).
