One way of cashing out a 401(k) plan is by changing jobs, according to Fidelity, but penalties still apply. Options when leaving a job include cashing out the account, rolling it into an individual retirement account, or if the employer allows, keeping it in the existing plan.
Employees who cash out their 401(k) are usually subject to a 10-percent penalty plus any income tax on the amount they withdraw. In high-income individuals, taxes and penalties can approach 50 percent of the withdrawal, warns Fidelity. Employees who qualify for a hardship withdrawal face similar penalties unless they qualify for an exemption.
An employee who leaves a job at age 55 is exempt from the penalty, advises Forbes. However, if he reinvests the money in an IRA, he forfeits the right to access the funds without penalty until age 59 1/2.
Many companies give employees the right to borrow against their 401(k) without actually cashing it out, according to Forbes. Using the option gives access to the lesser of $50,000 or half the amount of the account without the incurring the tax or penalty. However, it requires the employee to pay back all the money he borrows from the account, with interest, within five years of the withdrawal. A second potential pitfall of this option is that employers can demand quick repayment when the employee leaves the job. If the employee does not meet the demand, the employer reports the loan as a disbursement, and the employee is subject to the penalty and taxes.