Why Experts Say Cashing Out Your 401(k) Could Be A Costly Mistake

by Stacy Jackson

February 21, 2024

Financial experts advise that people plan for long-term financial security by exploring alternative options during the aftermath of a layoff.

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Financial experts warn people who have been laid off from their jobs to avoid cashing out on their 401(k)—unless they want to suffer big money consequences come tax time.

Retirement expert Anne Lester told CNBC Make It that the “long-term consequences” of pulling from a 401(k) plan early, or before 59 years and six months old, can be “very painful.”

The author of the upcoming book, Your Best Financial Life: Save Smart Now for the Future You Want, said withdrawing from a 401(k) before the retirement age could come with heavy tax consequences and starting over with retirement goals.

Lester explained the amount a person has in a 401(k) could be different from the actual amount they can withdraw.

“You may look at the number in your 401(k) and think, ‘Oh my gosh, I have $100,000,’ but you don’t actually have $100,000. Depending on your tax bracket, you may only get half of that.”

Owing income tax on the withdrawn amount is one thing. But CNBC Make It reported a person could also face an extra 10% tax penalty, according to the IRS. All in all, taxes and penalties could reduce the amount of money a person can actually get from a 401(k) plan.

Sacrificing the growth of savings already acquired through compound interest is another consequence of withdrawing from a 401(k) too soon.

Ed Slott, publisher of IRAHelp.com, said, “The greatest money-making asset anyone can possess is time,” CNBC Make It noted. And taking out funds is basically the same as restarting a retirement savings journey. Rebuilding funds to their previous level could be tough.

All hope is not lost. Lester shared alternative options like emergency savings, another source of income, 0% interest credit cards, or unemployment benefits to help cover living expenses.

Although, Lester noted that a credit card should be a last resort because debt can become an issue due to high interest rates.

Applying for unemployment benefits should be done “as soon as possible,” Lester said, according to the outlet.

“This is not the time to feel like, ‘Oh, I can’t do that,” Lester said. “That’s embarrassing.’ There’s no shame in getting laid off or getting unemployment benefits.” Eligibility varies by state. Generally, a person might qualify if they were let go from a job through no fault of their own, CNBC Make It noted. The amount a person gets will be based on a percentage of their earnings over the past 52-week period and capped at their state’s maximum amount.

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