Can I Cancel My 401k While Still Employed?

A 401(k) plan serves as a tax-advantaged, employer-sponsored retirement savings vehicle, designed to help employees build financial security for their future. These plans typically allow pre-tax contributions, which can reduce an individual’s current taxable income, and often include employer matching contributions, further boosting retirement savings. While primarily intended for long-term growth until retirement, employees may consider altering their participation or accessing funds while still employed. Understanding the rules governing these actions is important for financial planning.

Stopping Future Contributions

Employees generally have the flexibility to cease or modify their future payroll deductions to a 401(k) plan at any point during their employment. This process typically involves interacting with the plan administrator’s online portal, contacting human resources, or submitting a formal request. An employee can change their contribution rate to zero percent or a specified dollar amount for both traditional and Roth 401(k) contributions through their account dashboard. Stopping contributions only affects new money directed into the account from future paychecks. The existing balance remains invested according to the participant’s chosen allocations and continues to grow or decline based on market performance.

Stopping contributions does not constitute a withdrawal or “cancellation” of existing funds; it simply halts regular deposits from an employee’s salary. A consequence of ceasing personal contributions might be the forfeiture of any future employer matching contributions, as these are often contingent upon active participation. If an employee later decides to resume contributions, they can typically adjust their rate again through the same channels, though changes might take one or two payroll cycles to become effective.

Accessing Funds While Still Employed

While still employed, fully “canceling” or withdrawing all funds from a 401(k) is generally not permitted, as these plans are designed for retirement savings. However, certain limited avenues exist for accessing funds before separation from service. The availability of these options depends on the specific provisions of the employer’s 401(k) plan, as not all plans offer every type of in-service distribution.

One method of accessing funds is through in-service distributions, which some plans permit once a participant reaches age 59½. At this age, individuals may withdraw elective deferrals, including Roth contributions, and certain employer contributions without incurring the 10% early withdrawal penalty. Some plans may also allow access to rollover contributions or voluntary after-tax contributions at any time, regardless of age or financial need. These distributions are typically taxed as ordinary income, but the 10% penalty usually does not apply if the participant is over age 59½.

Another option is a hardship withdrawal, which allows access to funds for an “immediate and heavy financial need” as defined by IRS regulations. Qualifying expenses commonly include:
Medical care expenses for the participant, spouse, or dependents.
Costs directly related to the purchase of a principal residence (excluding mortgage payments).
Payments necessary to prevent eviction from or foreclosure on a principal residence.
Funeral expenses for a family member.
Expenses to repair damage to a principal residence that would qualify for a casualty deduction.

Plan administrators may require documentation to substantiate the hardship and proof that the financial need cannot be met from other reasonably available resources. Hardship withdrawals are generally limited to the employee’s elective deferrals, and earnings on those contributions may not be eligible for withdrawal.

A third way to access funds is through a 401(k) loan. This mechanism allows an employee to borrow against their vested account balance, rather than making a permanent withdrawal. The amount that can be borrowed is typically limited to the lesser of $50,000 or 50% of the vested account balance, though a minimum of $10,000 might be allowed if 50% is less than that amount. These loans usually have a repayment period of up to five years, with repayments made through regular payroll deductions, often with interest that is paid back into the participant’s own account.

A 401(k) loan is not considered a taxable distribution and does not incur an early withdrawal penalty, provided the loan is repaid according to its terms. Defaulting on a 401(k) loan, particularly upon leaving employment, can result in the outstanding balance being treated as a taxable distribution subject to taxes and potential penalties.

Tax Implications of Distributions

Any money distributed from a traditional 401(k) plan while an individual is still employed typically carries specific tax consequences. Distributions are generally taxed as ordinary income in the year they are received. This means the withdrawn amount is added to the individual’s other income for the year and taxed at their marginal income tax rate.

In addition to ordinary income tax, distributions taken before age 59½ are usually subject to a 10% additional tax, known as an early withdrawal penalty. This penalty is imposed by the IRS to discourage premature use of retirement funds. Therefore, an early withdrawal could mean paying both regular income tax and an extra 10% penalty on the distribution.

However, certain exceptions allow for penalty-free early withdrawals, although the distribution may still be subject to ordinary income tax. These exceptions include:
Distributions due to permanent and total disability of the account holder.
Distributions for unreimbursed medical expenses exceeding 7.5% of the individual’s adjusted gross income.
Distributions made to an alternate payee under a Qualified Domestic Relations Order (QDRO).
Distributions that are part of a series of substantially equal periodic payments (SEPP) over the individual’s life expectancy.
Distributions due to an IRS levy on the plan.