Whether or not you pay a penalty when cashing in stocks depends on what you consider a "penalty." The only case in which you will pay a true penalty is if you cash in stocks held in an individual retirement account or 401k too early. However, if you sell stocks held in a taxable account for less than one year, you will have to report short-term capital gains when you file your income tax return. Short-term capital gains are taxed at a higher rate, which many investors regard as a penalty of sorts.
Early Withdrawal Penalty
A traditional IRA or 401k plan allows you to defer taxes on money you invest for retirement. You have to reach age 59 1/2 before you can take money out of your retirement account without incurring a penalty. If you cash in stocks in your IRA or 401k account and withdraw the money before age 59 1/2, the Internal Revenue Service will assess a 10-percent penalty on top of any income tax you owe.
Capital Gains Taxes
When you cash in a stock, you pay tax on the appreciation in price. This tax is called the "capital gains" tax. If you buy a stock for $10 a share and you sell it for $20 a share, you pay taxes on the gain of $10 per share. If you hold the stock for more than one year, your capital gains tax rate is a maximum of 15 percent and could be as low as zero percent, depending on your tax bracket. If you hold the stock for less than one year, you pay the short-term capital gains tax rate, which is the same as your ordinary income tax rate. That can be as high as 35 percent for high earners. You pay no taxes when cashing in stocks that lose value.
In a few situations, you can cash in stocks early in an IRA or 401k and avoid the 10-percent penalty. If you become disabled, you can cash in stocks in a retirement account penalty-free. You'll also escape the penalty if you use the money to pay medical expenses that exceed 7.5 percent of your income. Another exception allows you to withdraw money from an IRA to pay the down payment on a first-time home purchase or college expenses for yourself or an immediate family member. You also can withdraw money from your 401k if you leave your job after age 55. In all of these situations, you still have to pay income tax on the money you withdraw.
You can do a few things to avoid incurring a penalty for cashing in stocks early. If you invest in a Roth IRA rather than a traditional IRA, you can withdraw your contributions penalty-free at any time. This is because you don't defer taxes on the money you invest in a Roth IRA. However, if you withdraw earnings in addition to contributions before you turn 59 1/2, you'll have to pay a 10-percent penalty on the earnings. If you are thinking about cashing in some stocks in your 401k plan, check first to see if your plan has a loan option. Many 401k plans allow you to borrow up to 50 percent of your balance. As long as you pay the loan back with interest within the designated time frame, you'll owe no taxes or penalties on the money.