A 401(k) retirement plan is taxed as ordinary income in the event of an early withdrawal, states Wells Fargo. If cashing out a plan before the age of 59 1/2, an individual may have to pay an additional 10 percent early-withdrawal penalty.
For any withdrawal from a 401(k) plan, investors are responsible for both federal and state taxes on the body of the savings. Early withdrawals from younger investors are subject to additional penalties, according to Fidelity.
In some circumstances, this 10 percent early-withdrawal penalty is waived. These situations include permanent disability or medical expenses that equate to more than 7.5 percent of an investor's adjusted gross income. Employees leaving their employer in or after the year in which they turn 55 may not be subject to the 10 percent penalty.
Whether cashing out a 401(k) plan for work-related reasons or due to a temporary financial hardship requiring immediate liquidity of funds, the consequences are ultimately the same. If the withdrawal is made in a time of financial hardship, investors can apply for a hardship withdrawal in hopes of avoiding additional penalties.
Fortunately for investors, there are several alternatives to cashing out an entire 401(k) plan, some of which may even keep the investment growing. Before liquidating a retirement account, investors are encouraged to explore IRA rollover options to avoid facing hefty taxes and fees, suggests Fidelity.