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.

I have a 401(k) account with a previous employer. I never contributed because I did not know it existed until I left that job. I cashed it out to pay off debts and they took 60% and told me the rest had to go back to the employer. This doesn't sound right to me. Help!

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Bill's Answer
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401k questions and answers
Highlights

  • Congress permits two types of hardship distributions.
  • File a Form 5329 to report the tax on early distributions.
  • Your plan administrator will send you a Form 1099-R.

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.

If you have outstanding debts that you are struggling with, get a no-cost, no obligation analysis of your debt options from a pre-screened specialist, click to see if you qualify: Free Debt Relief Quote.

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

306 Comments

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  • UA
    Aug, 2014
    up
    very informative
    Votes

  • JL
    May, 2014
    jay
    I accept a job in another state and therefore I withdrew $3,500 from my $12,500 in my 41k...I have a balance in my 41k of about $9,000 est. Does that mean when i get ready to file my taxes I may owe the IRS an est. of $1,000?
    0 Votes

    • BA
      May, 2014
      Bill
      You will be subject to 10% penalty on the $3,500 ($350) and then need to declare the amount withdrawn as income. How much you will owe depends on what else you earn during the year, how much you have withheld from that income, the deductions your entitled to claim, and the tax bracket in which you end up.
      0 Votes

  • MK
    Apr, 2014
    MN
    My wife received two 1099-R from her previous two employers. For both cheques which she received from her previous employers, we didn't transfer it in the time period of 60 days to her current employers retirement account. Now the question is what do we on our tax filing, as we were not aware of the 60 day period to transfer those funds, we thought that we could do them at any time before april 15th, so had mentioned that in our filing that those will be transferred, which didn't happen. So we are thinking of filing an amendend return, not sure how? Need help is figuring this out. Thanks, MNK
    0 Votes

    • BA
      Apr, 2014
      Bill
      Consult with a tax lawyer, CPA, or tax preparation specialist to learn how to handle the 1099-Rs, and how to roll these retirement accounts into IRAs after the roll-over deadlines.
      0 Votes

  • JG
    Mar, 2014
    JD
    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?
    0 Votes

    • BA
      Mar, 2014
      Bill
      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.
      0 Votes

  • KE
    Mar, 2014
    Kevin
    Can company take your part pay put in to 401K with your permission?
    0 Votes

    • BA
      Mar, 2014
      Bill
      With your permission? Sure.
      0 Votes