If you find yourself leaving your job or in financial hardship at age 40, you may wonder if you can, or should, cash in your 401k plan. Depending on your circumstances, your employer may allow you to access your account balance, but the Internal Revenue Service will charge you income taxes and possibly an early distribution penalty.
If you are 40 years old, you can only remove money from your 401k plan if you have left your job, or have a severe financial hardship for which your employer allows you to take distributions. The IRS qualifications for a severe financial hardship are an immediate and heavy financial need, but each 401k plan can define the hardships it will recognize. For example, some plans may recognize needs to prevent eviction from your primary residence, medical costs or funeral expenses.
Size of Distribution
The amount you can distribute depends on your reason for taking the distribution. If you left your employer, you can cash in your entire 401k plan. If, however, you are cashing in for a financial hardship, the IRS limits the amount of the distribution to the amount needed to satisfy the hardship. It also allows enough extra to cover the income taxes and early withdrawal penalties, if applicable, on your financial hardship distribution.
Taxes and Penalties
Whenever you cash in your 401k plan, you must pay income taxes on the distribution amount because 401k plans offer pretax savings. When you cash in your 401k plan at 40, you must also pay a 10 percent early withdrawal penalty in addition to your income taxes. The IRS only offers a few circumstances in which you can cash in your 401k plan at 40 and not pay a penalty. These include if the amount of the distribution is equal to your medical expenses for the year that exceed 7.5 percent of your adjusted gross income, if a court orders the distribution in a divorce, or if you suffer a permanent disability. The IRS does not consider being unemployed as a financial hardship.
Alternatives to Cashing In
If you leave your job at age 40, instead of cashing in your 401k plan, consider rolling it into another qualified retirement plan, such as a traditional IRA or 401k plan with a new employer. With a traditional IRA rollover, you maintain the tax-sheltered nature of the plan, and the money continues to grow tax free. In addition, you do not have to pay income taxes until you take a distribution from the IRA. And, if you wait until you turn 59 1/2 years old, you do not have to pay an early withdrawal penalty.
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