8 Questions to Consider Before Cashing Out Your 401(k)

If you're thinking it might be time to cash out your 401(k), be sure to ask yourself these questions to set yourself up for a relaxing retirement.

March 14, 2022
8 Questions to Consider Before Cashing Out Your 401(k)
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Photo by LOGAN WEAVER on Unsplash

You’ve invested a significant portion of your earnings into your 401(k)--great work! Investing in a 401(k) can set you up for the relaxing retirement you deserve. 

Now you’re considering cashing out these savings, and you’re feeling the weight of this decision. There are several questions you can ask yourself to feel confident that you’re ready to unlock your investment. 

1. What is a 401(k)?

First, it’s important to make sure you fully understand how your 401(k) works. A 401(k) is an investment product sponsored by your employer. It’s not possible to set up a 401(k) without a company sponsorship.

For traditional accounts, your employer deposits a percentage of your salary into your 401(k) retirement account. This is helpful while you’re working because the money that goes toward your 401(k) is deducted from your overall pre-tax income. It will be taxed, however, when you eventually withdraw that money from your account. 

There is also a 2nd type of 401(k), the Roth. For those types of accounts, the contributions come after taxes, but when you make a withdrawal, you don’t pay tax on it.

The IRS sets limits for how much you can contribute to your 401(k) yearly, and the actual investments made are selected from a predefined “menu” that balances risk and growth.

2. Are you still employed by your 401(k) sponsor?

If you are still employed by the company sponsoring your 401(k), you won’t be allowed to withdraw the funds. Instead, you’ll have to wait until you are officially no longer with that company to cash out.

If you have already left your company, then you have several options:  cash out, roll  the money into an independent retirement account like a Roth IRA, keep your 401(k) with your now former employer, or transfer it to your new employer.

3. What is your current age?

Age is a serious consideration when deciding whether or not to cash out your 401(k). If you are below the age of 59 and a half, you will be subjected to a 10% tax penalty in addition to income taxon the amount you withdraw. 

There are exceptions to this rule, however. If you are experiencing a hardship and can demonstrate “immediate and heavy financial need,” you may be able to avoid the penalty.

If you are above the age of 59 and a half and nearing retirement, then withdrawing the money in your 401(k) makes more financial sense. 

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4. How much is your taxable income? 

Cashing out your 401(k) will lead to a massive boost to your taxable income the year you make the withdrawal. You’ll need to consider if now is the right time to take on this additional tax burden.

5. Can you wait for the funds?

One of the major benefits of an active the 401(k) account is how your money can grow, tax free, year after year. If you do cash out now, you’ll be losing this sizable advantage.

While cashing out your 401(k) may sound like a simple and quick process, it can take quite a bit of time to actually receive the funds. At best, it will take several weeks, and at worst, longer.

If you are withdrawing the funds because you are facing an urgent crisis, be aware that the funds may not arrive with enough time to make a difference.

6. Are you balancing my short term and long term needs?

When you cash out your 401(k), you will gain access to the funds you can use to cover immediate needs like paying down debt, buying a car, making a down payment on a house, etc. While this may seem appealing in the short term, you may be threatening your long term financial health.

Remember that your retirement nest egg can continue to grow in your 401(k). If you cash out now, you will lose out on that growth and potentially be left underfunded as you enter retirement.

You’ll have to consider your age and long term financial goals before deciding if cashing out is right for you. There may be situations where it's necessary, but it’s absolutely vital that you keep an eye on your retirement savings and save the proper amount.

7. Are you willing to lose protection from creditors?

One of the benefits of having money locked away in a 401(k) is that it can’t be seized by creditors. If you are facing significant debt and bankruptcy, you will lose this protection if you withdraw your 401(k) funds.

There may be situations where withdrawing the funds is essential to right your financial ship, but it should be very carefully considered.

8. Have you considered other methods for securing cash?

Depending on your unique situation, you may decide that it’s best for your long term financial health to keep your money in its current account. But don’t worry, there may be other ways  to secure the cash you need now. 

If you sell other investments, for example, you’ll be subject to tax, but you won’t face the penalties of early 401(k) withdrawal. Additionally, selling investments gives you immediate access to cash. 

You may also be able to take out a short term bank loan. While it’s important to consider the interest rates and credit implications, it may be more advantageous than cashing out your 401(k)

If you’re a homeowner, you can also access funds that are tied up in your home equity. Through Truehold’s Sale-Leaseback, for example, you can sell your home and access all of your home equity without having to leave your house. By becoming a renter, you access substantial wealth without taking on any debt. If you’re interested in learning more about this popular way to get cash without compromising your quality of life, call a Truehold Advisor at 314-353-9757.

Be intentional when cashing out your 401(k)

Taking the time to review all the effects of cashing out your 401(k) will ensure that you make the perfect choice for your unique circumstances. You can also consider reviewing your long and short term goals with a qualified financial advisor when making this major decision. Congratulations on your growing investment, and good luck!

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Written by
The Truehold Team
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The Truehold Team, a group of professionals in real estate, finance, technology, and senior living, is committed to providing innovative solutions for homeowners to access their equity.
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Truehold's blog is committed to delivering timely and pertinent insights in real estate and finance, purely for educational and informational purposes. Crafted by experts, our content is thoroughly reviewed to guarantee its accuracy and dependability. Although designed to enlighten and engage, our articles are not intended as financial advice and should not be the sole basis for financial decisions. Our stringent editorial practices ensure the integrity of our content, empowering our readers with valuable knowledge.

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