Can I Cash Out a 401(k) While Still Employed?

A 401(k) plan serves as a widely used retirement savings vehicle, allowing individuals to set aside pre-tax income for their future. These plans grow tax-deferred, meaning taxes are only paid when funds are withdrawn, typically in retirement. Many participants eventually consider accessing these savings before traditional retirement age, often wondering about the possibility of doing so while still employed.

Understanding In-Service Withdrawal Eligibility

Accessing 401(k) funds while still working, known as an in-service withdrawal, depends on specific rules set by the Internal Revenue Service (IRS) and the employer’s 401(k) plan document. Availability varies significantly.

Employee contributions, such as elective deferrals, are restricted from in-service withdrawal before age 59½, unless specific conditions are met. However, after-tax contributions or amounts rolled over from a previous retirement account may be accessible earlier if the plan allows. Employer contributions follow a vesting schedule, meaning an employee gains full ownership of these funds over time. Only vested balances are eligible for any distribution.

Specific Types of In-Service Withdrawals

Several scenarios allow participants to take in-service withdrawals from their 401(k) accounts. Each type has distinct requirements and limitations.

Age 59½ Withdrawals

One common condition is reaching age 59½. At this age, many 401(k) plans permit participants to take withdrawals from all vested funds without restriction, even while still actively employed. This age milestone marks a point where the IRS allows penalty-free access to retirement savings.

Hardship Withdrawals

Another avenue for early access is through a hardship withdrawal. The IRS defines a hardship as an “immediate and heavy financial need” that cannot be met through other reasonably available resources. Recognized hardship reasons include:
Medical care expenses for the employee, spouse, or dependents.
Costs directly related to the purchase of a primary residence.
Tuition and related educational fees for postsecondary education.
Expenses to prevent eviction or foreclosure on a principal residence.
Burial or funeral expenses.
Costs for the repair of damage to a principal residence due to a casualty.
The withdrawal amount must be limited to what is necessary to satisfy the specific financial need.

Qualified Reservist Distributions

For military reservists called to active duty for 180 days or more, qualified reservist distributions may be available. This allows eligible individuals to withdraw funds without incurring the early withdrawal penalty.

In-Service Rollovers

Some plans permit in-service rollovers of vested funds to an Individual Retirement Account (IRA) or another qualified plan. This allows participants to consolidate or manage their retirement savings outside of the employer-sponsored plan while remaining employed. This differs from a cash distribution as the funds remain within the retirement savings system.

Plan Termination Distributions

If an employer terminates its 401(k) plan, employees may access their vested account balances, even if they remain employed by the company. Such distributions are subject to regular income tax.

Tax and Penalty Implications

Taking an in-service withdrawal from a 401(k) plan carries tax consequences and potential penalties. Any amount withdrawn from a traditional 401(k) is taxed as ordinary income in the year it is received. This means the distribution is added to your other taxable income for the year, potentially pushing you into a higher tax bracket. For eligible rollover distributions, plan administrators are required to withhold 20% of the distribution for federal income tax. This mandatory withholding applies even if the participant intends to roll over the funds.

In addition to ordinary income tax, distributions taken before age 59½ are subject to a 10% early withdrawal penalty. This penalty is an additional tax on the withdrawn amount. For instance, a $10,000 withdrawal could incur a $1,000 penalty on top of regular income taxes.

There are several exceptions to this 10% early withdrawal penalty, including:
Distributions made due to total and permanent disability.
Those taken as part of a series of substantially equal periodic payments (SEPP).
Withdrawals for unreimbursed medical expenses exceeding a certain percentage of adjusted gross income.
Qualified reservist distributions.
Distributions from a terminated plan if specific conditions are met.
State income taxes may also apply to 401(k) withdrawals, depending on individual state tax laws.

Accessing Funds Through 401(k) Loans

A 401(k) loan offers an alternative method to access funds from a retirement plan without incurring immediate taxes or penalties. Unlike a withdrawal, a loan is not considered a taxable distribution as long as it is repaid according to the agreed-upon terms.

The availability of 401(k) loans is optional for plans. If offered, federal regulations set limits on the amount that can be borrowed. A participant can borrow up to the lesser of $50,000 or 50% of their vested account balance. An exception allows borrowing up to $10,000, even if 50% of the vested balance is less than that amount.

Repayment terms for 401(k) loans require repayment within five years, though loans for a primary residence may have a longer period. Repayments occur through regular payroll deductions, ensuring consistent payments. The interest paid on the loan goes back into the participant’s own 401(k) account, effectively paying interest to themselves.

Failure to repay a 401(k) loan according to its terms can have financial repercussions. If the loan is not repaid, the outstanding balance is treated as a taxable distribution. This means the unpaid amount becomes subject to ordinary income tax. If the participant is under age 59½ at the time of default, the outstanding balance may also be subject to the 10% early withdrawal penalty.