Cashing out a 401(k) can be a tempting idea, especially if you are facing financial difficulties or need to raise money for a major purchase. But even though the money in the account belongs to you, it is subject to certain rules and restrictions due to the tax advantages it provides account owners. One of the rules related to cashing out a 401(k) relates to the employment status of the account owner. You are allowed to cash out a 401(k) while you are employed, but you cannot cash it out if you're still employed at the company that sponsors the 401(k) that you wish to cash out.
Employment Status
Internal Revenue Service rules prohibit workers from cashing out a 401(k) while they are still employed at the company that sponsors the plan. If you were to resign or be terminated from the company that sponsors your plan, you can cash out the account rather than roll the money into an Individual Retirement Account or another company 401(k) plan. By leaving the company that sponsors the plan, you can cash out your 401(k) account even if you're currently working for another company.
Hardship Withdrawals
Hardship withdrawals are allowed by the IRS, but employers are not allowed to provide them. The cost of administering hardship withdrawals is too high for some small companies offering 401(k) plans to their employees. Hardship withdrawals can be compared to a partial cash-out while working for an employer who sponsors the plan because the money does not have to be repaid to the account. Hardship withdrawals are allowed only for certain reasons that include unreimbursed medical expenses, to buy a primary residence, to pay college tuition costs, to pay funeral expenses and to avoid eviction.
Loans
IRS rules do allow employees to take loans against their 401(k)s while still working for the company that sponsors the plan. Workers can borrow up to 50 percent of the vested account balance, up to a maximum of $50,000. Loans from 401(k)s must be repaid within five years. Loan repayments can, however, be extended to 10 years if the loan is used to make a down payment on the worker's primary residence.
Taxes
If you cash out a 401(k) before reaching 59.5 years of age, your employer is required by the IRS to withhold 20 percent of the distribution, and you will face a 10 percent penalty for the early withdrawal. If you're cashing out a 401(k) after age 59.5, you will not have to pay the 10 percent penalty.
