Should You Cash Out Your 401(k)?

If you own a 401(k) retirement plan then you are already familiar with the way they work: you put some money in, your employer offers some sort of a match, and upon retirement you can withdraw the funds to live on. During the 1990s, many 401(k) owners made great sums of monies only to lose their shirt later when the internet bubble burst. If you were fortunate, you saw it all coming and changed your investments around to avoid a big loss later. There is, however, something else that can affect your 401(k) balance perhaps more so than a plunge in its value: cashing out the 401(k) early. Let's take a look at what cashing out means and if it could possibly have any redeeming value for you.

Let's face it: That $220,000 balance in your 401(k) account sure looks tempting! More so if you could really use the money! However, if you cash out your 401(k) ahead of time you could be faced with:

Paying an administrative fee for the early cash out.

Paying federal taxes and penalties for cashing out before you are age 59 ½.

Paying state taxes too.

Soon, that $220,000 balance plummets to $160,000 or less all because you decided to take the money and run.

On the other hand, if you borrow the money from your 401(k) you can save yourself a big hit and still have access to your funds, moreover:

Borrowing from your 401(k) means no penalties to you as long as the loan is repaid.

Borrowing from your 401(k) means that the interest charged to you is actually paid back to you. You make interest off of your own loan!

Borrowing from your 401(k) means only paying a small administrative fee to access your funds.

Not all plans will allow you to borrow and, again, you have to repay your loan. Should you quit, get fired, or are laid off then your loan becomes due immediately. If you do not repay these funds then the loan is treated as a disbursement and you will be taxed on the distribution.

Of course, if you really need the money and you cash out your 401(k), that decision isn't the end of the world. It could be that you already have sufficient retirement funds on hand or that you are young enough to recoup the disbursement. While the experts will warn against this move, cashing out a 401(k) could be smart especially if the funds are used for your home, education or for a medical need.