Once you've left your job, suffered a permanent disability or reached age 59 1/2, you're allowed to tap your 401(k) for any reason. However, before you take a check and run, make sure you understand the potential fees that could cut down on the portion of your cash-out you get to keep.
Depending on how you invested the money in your 401(k) plan, you might have to pay surrender or transfer charges when you cash out. These fees are typically imposed on annuity contracts when you cash out before the money's been in the investment for a certain period of time. Typically, these fees decrease over time and eventually disappear. For example, you might have to pay a 10 percent surrender fee if you cash out in the first three years and then the fees goes down by 2 percent every year after that.
No matter when you cash out your 401(k), you're going to have to share some of the proceeds with Uncle Sam. Since you didn't have to pay taxes on the money you contributed to the plan, you have to add the distribution to your taxable income for the year and it gets taxed at your ordinary income tax rate. For example, if you fall in the 28 percent tax bracket, that leaves you only 72 percent of the withdrawal after the Internal Revenue Service gets its share.
Early Withdrawal Penalties
If you're under 59 1/2 years old, the IRS hits your withdrawal with an extra 10 percent income tax on the distribution. For example, if you siphon out $8,500, not only do you owe income taxes, you also owe an $850 additional tax penalty when you file your tax return unless an exception applies.
Even though you're not 59 1/2, there's some situations where you can still drain money from your 401(k) without incurring the penalty. For example, if you're permanently disabled, take a qualified reservist distribution or you leave your job after you turn 55, you're allowed to take out any amount without paying the early withdrawal penalty. You're also exempted from the penalty for medical expenses exceeding 10 percent of your adjusted gross income or the amount withdrawn when the IRS levies your 401(k) plan.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."