You really should resist the siren call of cashing out your 401(k) (2024)

FAQs

Why should you not cash out your 401k? ›

If you haven't reached age 59½, an early 401(k) withdrawal could trigger penalties and taxes, as well as impact your retirement savings in the long term.

According to Ramsey, you should almost never take money out of a 401(k) or IRA — even if you have a ton of debt. The reason? Early withdrawals have steep penalties. For example, if you withdraw from an IRA without a valid reason, the IRS will charge you a 10% tax penalty.

In other words, if you have a solid financial plan, and your 401(k) is well-optimized, sometimes the best thing to do in a market downturn is to stay the course, especially if you are a younger investor with years until retirement.

Convert the account into an individual retirement account. Start cashing out via a lump-sum distribution, installment payments, or purchasing an annuity through a recommended insurer.

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.

If you withdraw from your 401(k) before you reach age 59½, you may have to pay a 10% additional tax on the distribution. This tax applies to the amount received that you must include in income. The 10% tax will not apply to distributions before age 59½ if you qualify for an exemption.

But if you have an urgent need for the money, see whether you qualify for a hardship withdrawal or a 401(k) loan. Borrowing from your 401(k) may be the best option, although it does carry some risk. Alternatively, consider the Rule of 55 as another way to withdraw money from your 401(k) without the tax penalty.

According to Buffett, you should invest 90% of your retirement funds in stock-based index funds. According to Buffett, the remaining 10% should be invested in short-term government bonds.

The only time you should even consider taking money out of your retirement accounts early is to avoid a bankruptcy or foreclosure. Otherwise, hands off the 401(k)! When you do the math, you'll see that you're better off leaving your retirement investments alone and finding other ways to get rid of your debt.

What Happens to My 401(k) If the Stock Market Crashes? If you are invested in stocks, those holdings will likely see their value fall. But if you have several years until you need your retirement account money, keep contributing, as you may be able to buy many stocks on sale.

What happens to my 401k if the dollar crashes? ›

If the dollar collapses, your 401(k) would lose significant value. Exponential inflation would result if the dollar collapsed, decreasing the real value of the dollar compared with other global currencies, which, in effect, would reduce the value of your 401(k).

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.

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.

What is the 7 Percent Rule? In contrast to the more conservative 4% rule, the 7 percent rule suggests retirees can withdraw 7% of their total retirement corpus in the first year of retirement, with subsequent annual adjustments for inflation.

An early withdrawal from a 401(k) plan typically counts as taxable income. You'll also have to pay a 10% penalty on the amount withdrawn if you're under the age of 59½.

The amount of cash that's in the fund when you retire is what you will receive as a pension. Thus, there is no guarantee that you will receive anything from this defined contribution plan. The fund may lose all (or a substantial part) of its value in the markets just as you're ready to start taking distributions.

Dangers of using your 401(k) to pay off a mortgage

The main reason not to use your 401(k) to pay off a mortgage is that it takes funds away from your retirement nest egg. Not only are you removing a lump sum from your retirement account, but you're losing years' worth of accrued interest on that money.