401k plans are offered by many employers and allow individuals the opportunity to plan for retirement in advance. A 401k is an investment plan and the funds it contains are not readily available under an individual reaches retirement age.
How 401k Plans Work
When an employer offers a 401k retirement plan to its employees, the employees are given the option to set aside a portion of their paycheck to be placed into the 401k investment. The 401k funds are then invested. Interest accrues over time from these investments and is distributed to the employee when he or she retires and cashes out the investment. Employees are usually allowed to choose how their 401k plans are invested.
Some employers will offer 401k matching. When an employer matches an employee’s contributions, the employer places money into the retirement plan along with the employee. Most matching programs, however, are not equal, and the employer will only match a certain percentage of the employee’s total investments.
When Can a 401k Plan Be Cashed Out?
A 401k plan is not intended to be cashed out until an individual reaches retirement age. Occasionally, however, the funds can be accessed sooner. The funds must be vested in order to be accessible. A fresh 401k investment cannot be accessed by anyone, no matter what his or her age may be. A vested 401k is a retirement investment that has aged enough to be successfully cashed out. Being allowed to cash out a 401k requires that at least one of the following circumstances be met:
- An individual has reached age 59 ½
- An individual resigns from the company that holds the 401k
- An individual can prove a financial hardship.
Unfortunately, the definition of “financial hardship” is very limited. Although medical expenses are considered a financial hardship, an employee will most likely not be allowed to claim any other form of unsecured debt (such as credit card debt) as a hardship in order to gain access to his investment. Acceptable forms of hardship for cashing in a 401k investment are:
- Medical expenses
- Threat of foreclosure
- College related expenses for the employee or his immediate family members
- The purchase of a home
Consequences of Cashing Out a 401k Investment Early
Anytime an individual withdraws a 401k, he will be expected to pay taxes on the accrued amount of the investment. In many cases he will also be expected to pay a penalty fee for cashing out the funds prior to reaching retirement age. The penalty fee for cashing out a 401k is usually around 10% of the total investment amount.
In addition, consumers who opt to cash out their retirement plans for uses other than retirement should consider that by taking the money now, the money will not be there to serve its intended purpose–financial support when the consumer is no longer able to work.
Alternatives to Cashing In a 401k When Employment is Terminated
Employees that lose their jobs or resign from their jobs may opt to cash out any retirement investments held by the company. This is not, however, the only option. If the employee intends to reinvest the funds immediately, he or she can opt to roll the funds over into a Roth IRA without ever cashing out the investment.
Consumers may also check into whether their new place of employment offers a 401k retirement program. If it does, the original investment can be rolled over into the new company’s 401k plan.