How to Cash Out Your 401k

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There are many restrictions on the cash out of a 401K while a person is still working and is under the age of 59 ½. The thing is that to cash out when you have not reached 60 or at least 59 ½ subjects your funds to an excise tax which is equivalent to 10 percent of the amount that was distributed. Here are some simple steps on how to cash out your 401k plan effectively.

Step 1

Determine if your cash out is allowable - One reason to cash out is due to financial hardships. Accordingly, financial hardships are described as those that include: the need to buy primary residence; the need to avoid a foreclosure or an eviction from your primary residence; the need to pay higher education expenses; the need to pay medical bills which were not covered by the insurance of the employee, his/her spouse, and/or beneficiaries except for non essential medical expenses such as cosmetic surgery; the need to pay for funeral expenses of the employee’s deceased child, spouse, parents or beneficiaries; and the need to pay for home repairs due to casualty loss that is deductible.

Step 2

Determine what non-allowable cash out are - There are cash out reasons that are not allowed even if those fall under the financial hardship categories. As stated, in order to maintain the tax advantage for the income that are deferred under the plan, the law requires that the money be kept until the employee reaches the age of 59 ½.

Step 3

Determine the taxes to be paid for non-allowable cash out - Other than the proper age to cash out your 401k, any cash out is considered as ordinary income and is also subject to normal taxation. This means that if the employee cashes out before he/she reaches the age of 59 ½ then the employee will incur a penalty tax of 10 percent on top of the ordinary income tax.

Step 4

If you have not reached age 59 ½, determine whether or not you fall under the exceptions to the 10 percent penalty tax - Even if you have not reached the age of 59 ½ there are certain exceptions to the penalty tax such as when the employee dies before the age of 59 ½, when the employee becomes permanently disabled, when the employee separated from service after the age of 55, when the employee has made a substantial period payment under section 72t, upon a qualified domestic relations order, or due to forcible medical expenses.

Step 5

Rethink about your plan to cash out - Essentially, experts do not encourage you to cash out your 401k because of the many disadvantages such as the tax penalty alone. Instead of cashing out, you are encouraged to either leave your 401k as it is, to roll over your 401k to another plan, to roll over your 401k to an IRA or to proceed with your cash out but pay the penalties (once again the last option is not recommended).

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