Information & Advice on 401(k) Cash-Out Penalties

I cashed out my 401(k) and they took 60% and told me the rest had to go back to the employer. This doesn't sound right to me.

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401k questions and answers
Bill's Answer: Answered by Daniel Cohen

You state in your question that you never made contributions to your 401(k) account. Employers only match based on contributions of the employees. Therefore, if you did not contribute then it is likely that neither did your employer. Either your employer did not create an 401(k) for you and instead enrolled you in a private pension plan, or if you had a 401(k) account and was not aware of it, the administrator miscalculated the penalty and taxes for your distribution.

We will discuss 401(k) distributions in a moment. Generally, however, unless you qualify for hardship distributions from a 401k plan, it is very expensive to liquidate 401k funds, and therefore, if you are looking to solve a debt problem you may want to look elsewhere.

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Now onto 401(k) distributions, penalties and solutions for you.

401(k) Distributions

In general, if you withdraw money from a traditional individual retirement account such as a 401(k) or other qualified retirement plan before you turn age 59½, you are subject to penalty of 10%. The taxable amount is also included in your taxable income. This 10% tax is in addition to regular income taxes. You can avoid this additional tax penalty if you meet certain criteria, but you cannot avoid including your retirement withdrawal from your taxable income.

What this means is that if you withdraw $10,000, you may only end up with $6,000 (or less) in your pocket. Some withdrawals can be made without penalty, but these usually require a true financial hardship.

See the IRS document 401(k) Resource Guide - Plan Participants - General Distribution Rules for more information on distributions.

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Cashing-out a 401(k) Tax-Free

Let us say you leave an employer, and your former employer’s 401(k) administrator wants to close your account and give you a distribution. If you accept the distribution and deposit the check into your usual checking or savings account, you are liable for significant taxes and penalties.

To avoid the taxes and penalties, roll the funds from the 401(k) into an IRA, or your new employer’s 401(k). Your new employer’s plan administrator will be able to assist you if you want to go this route. If you want to set up an IRA account, your financial institution will be more than happy to set up an IRA for you. See the IRS document "Publication 590 (2008), Individual Retirement Arrangements (IRAs)" for more information on IRAs, and for more information on rollovers, see the IRS document "Topic 413 - Rollovers from Retirement Plans."

Regarding the cashing-out penalties, rules vary from company to company, it becomes difficult to calculate the penalties. Contact the plan administrator at your previous employer to find out the actual modalities of your cash out (early withdrawal), and an accounting of the taxes and the penalties they charged you.

I hope this information helps you Find. Learn & Save.

Best,

Bill

Bills.com

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Comments (301)


JD G.
Kinder, LA  |  March 31, 2014
My dad is 50 years old and has $30,000 in his 401k. He wants to retire by 60. Is there anywhere he could roll his 401k to boost it in 10 years?
Bills.com
March 31, 2014
I believe what your dad wants to do is:
  1. Make sure he takes full advantage of his employer's match, if one is offered.
  2. Look at how his funds are invested now and compare them to the choices offered by his employer, to see if he may benefit from adjusting his investment mix to something more aggressive. If he has a co-worker who has researched the options, that can be a source of good information.
Kevin E.
Waterloo, IL  |  March 06, 2014
Can company take your part pay put in to 401K with your permission?
Bills.com
March 10, 2014
With your permission? Sure.
Alejandra .
Fort Worth, TX  |  March 03, 2014
I have a question from my father. I July 2013 he left his company of 33 years to work for another. At that time he had a balance of $85k in his 401k plan but $10k on a 401k loan he had previously taken out. Does the 10% early withdrawal penalty applied towards him if he did an IRA rollover on the remaining $75k? The remaining balance of the loan was taken from the 401k check they sent him for the rollover.
Bills.com
March 10, 2014
The penalty tax should apply to the loan balance due, and not the other amount rolled into the new company's 401(k) or your father's IRA.
MaryAnn C.
Cedar Grove Twp, NJ  |  February 19, 2014
I took a 401k loan out when my husband and I bought our house last June. I left my job shortly thereafter and started a new job in October. Almost immediately after I started a new job, my husband was laid off so paying back the loan was impossible. The balance is only $3900, but the plan does not allow partial repayments so I'm going to default on the entire balance of the loan (They haven't defaulted yet, even though they should have). Can I offset the taxes and penalties we will owe by contributing that amount to an IRA throughout the year? Also, in the Special Tax Document it says, "The loan offset amount is treated as a distribution to you at the time of the offset and will be taxed (including the 10% additional income tax on early distributions, unless an exception applies) unless you do a 60-day rollover in the amount of the loan offset to an IRA or employer plan." What is the 60 day rollover they talk about? Can I still do that?
Bills.com
February 27, 2014
Consult with an experienced tax preparer or tax lawyer to receive an interpretation of the rules you mentioned, and if the 60-day rollover rule applies in your situation.
Frank Frank S.
Austin, TX  |  February 16, 2014
I took a loan out for my 401k and was subsequenty fired from my job. I then received my w2 with the amount of the remaining loan. This was added to my income return and filed. My loan is still marked as pending payment. My question is whether I will have to input that amount in my taxes next year when I receive my 1099 or if I just need to pay the 10% penalty for defaulting on my loan.
Bills.com
February 18, 2014
If you are issued a 1099, consult with a tax preparer to file an amended return.
Beth P.
Town Of Glenville, NY  |  February 13, 2014
I am looking for advice. I was laid off and withdrew approx. 50k from my 401k to purchase a house to flip. I have now been rehired at my previous employer and I am told if I reinvested in to another 401k within 60days I could avoid taxes and penalties however the new house will not sell before then so I will not have the liquid cash. I’ve been trying to figure out ways to avoid the taxes and penalties especially since I am now going to show huge income this year. If I put this money in to a 529 plan for my kids would it help? someone also suggested upping my investment from my pay check each week to the max in to my 401k and living off of the money that I already took to lower my taxable income. Any suggestions would be appreciated.
Bills.com
February 14, 2014
Speak with an experienced tax professional. It sounds like you will be subject to the 10% penalty for the withdrawal, as well as declaring the money as income.

One thing you can do is to fund an IRA before April 15th, to the maximum allowed for your income. I don't think that the 529 contribution will count, as the cutoff date for tax year 2013 was at year's end.
Lw L.
Debary, FL  |  February 04, 2014
I would love help with a question we have... My husband closed out his 401k in 2012(for bills); we payed taxes on it in 2013. We received another form for taxes this year, for 2013. How can this happen when we closed out the account in 2012 & already payed taxes on it?
Bills.com
February 05, 2014
It sounds like you received the form in error, if all money from the account was taken out in 2012 and the account closed. I recommend that you start by speaking with the plan administrator, to see if you can straighten this out. Ask them to file a corrected 1099. If you get nowhere, file your taxes with a tax professional, so you can include the errant form along with an explanation on why you are not declaring the money as income.
ASHLEY O.
Warren, RI  |  January 30, 2014
I am 25 years old with only $3,500 in my 401k right now, though I have this personal loan weighing on me that I would like to disappear. Is it worth pulling the small amount of money from the 401k to free the weight off my shoulders? With this amount and some savings I have I can pay off my debt. I feel that with such a small amount of money I will not hurt my "retirement."
Bills.com
January 31, 2014
It may not be so much about hurting your retirement as the bang for the buck. You will have to pay a 10% penalty for withdrawing the money, plus pay taxes on it.

You need to decide if the benefit of reducing your stress by paying off the personal loan is worth more than the money you will forfeit. How high the interest rate is on the personal loan certainly is an important factor, too. Before you decide to withdraw the money, speak to your plan administrator to see if you are eligible to borrow enough money from your account to pay off the loan. That avoids the penalty and taxes.
Ari W.
Boston, MA  |  December 17, 2013
Looking for some advice... I quit my job to finish my Masters degree over the last year and as such did not work in 2013, hence no income. I have a 401K account (currently at 46k) with my old employer and am thinking of liquidating it. I have a home, hence a mortgage 2k and other expenses such as property taxes, student loans which are all tax deductible. It is my understanding that I can not offset any of these expenses if I do not have taxable income and they will all be forgone. I have been living on savings but am running low and this perhaps may be the best time to liquidate since my tax bracket is low. I am aware that there is a 10% penalty of the top to be paid when filing my tax return and the plan administrator will keep 25.25% for state and federal taxes, cutting me a check of $34,385. I am going to be starting my new job in mid January and since I do not wish to keep that money with my old employer, this seems like a good idea to liquidate now for taxable income for 2013 especially since my home deductible expanses (mortg int + prop tax) are 19,500 and 2,000 in student loan interest in 2013. Would you please let me know what you think... is this smart? It needs to be said that my future employer has a generous retirement benefits so I will be able to easily rebuild it. also, I can always put a portion into a ROTH IRA. Oh, I am 29 so I have another 25+ years before retirement. Would you proceed with 401k liquidation in my situation? Thank you, Ari
Bills.com
December 23, 2013
Ari, I am hesitant to recommend liquidating the 401k, given the taxes and penalties you will incur. However, you give some solid reasons for considering it. Part of the equation is how badly you need the cash to stay afloat, before your income from a new job kicks in. Another part is how much are the tax deductions really worth compared to the cost of the penalty. If you are paying 10% in penalties, $4,600, isn't that more than the amount you would reduce your taxes by claiming the mortgage interest and student loan deductions?
T. B.
Gill, MA  |  September 09, 2013
On July 24th 2013, I worked for a company for 7 years, was transferred to a a newer building working for that department for a year then i was laid off due to company's loss of production. I am closing out my 401k, i know there is a 10% penalty fee, plus the 20% extra in taxes everyone has been telling me. Do they take the 20% taxes out at the time of cashing out my 401k? Or do i give the 20% taxes at end of year? Or will i be taxed both time, on my cash out check AND the end of year tax refund? I have until the 24th this month to take action on what i want to do with my 401k, please if possible let me know an answer soon, i am looking for work and hope to find something soon, but until then i'm at a loss to use some of my 401k to pay bills due.
Bills.com
September 10, 2013
The 20% is a standard amount that is withheld from your withdrawal at the time you take the withdrawal. That does not mean it necessarily covers the taxes you'll owe when you file your 2013 tax return. When you file, you will need to declare the amount you withdrew as income. Depending on your tax bracket, how much you've had withheld from your income, and the deductions you're entitled to claim, you may owe more or less than 20%.

You pay the 10% penalty when you file, using the proper line on the tax return to note the amount withdrawn. Enter into your return 10% of the amount shown in Box 1 of the 1099-R you will receive to accurately account for your total tax obligation.
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