People who cash out a 401K early need to know that they must pay both federal income tax and a 10 percent penalty tax on the amount they withdraw. Additionally, the withdrawn money no longer generates income from investments, and it is not available when it is needed during retirement. However, in certain hardship cases, the penalty tax is waived. There are alternatives to cashing out a 401K.
To avoid paying the penalty tax for cashing out a 401K, a person must be over 59.5 years old, disabled or undergoing financial hardship. Financial needs that usually qualify for hardship withdrawal include medical emergencies, tuition and other educational expenses, buying or repairing a home, or avoiding eviction or foreclosure.
One alternative to cashing out a 401K is taking out a loan on it. As of 2014, a loan from a 401K account is usually limited to $50,000 or 50 percent of the value of the 401K, whichever is smaller. Unlike a normal loan, there is no outside lender involved. The investor pays back the money to himself. Alternatively, rolling the funds from a 401K into an IRA account may offer more flexibility in withdrawing money. IRA fees vary from plan to plan, and it is important to study individual plans carefully before committing to them.