Can I Cash Out My 401k at Age 65?

Cashing out a 401(k) at age 65 is a financial event that represents a transition from accumulating assets to using them for income. The decision to take a full, lump-sum distribution requires an understanding of withdrawal regulations, tax implications, and other available options. Navigating this process involves aligning the decision with your personal financial goals and retirement timeline.

Withdrawal Eligibility and Key Rules at Age 65

At age 65, you are past the Internal Revenue Service (IRS) age threshold of 59½. This means any funds you withdraw from your 401(k) are not subject to the 10% additional tax on early distributions. This rule allows for penalty-free access to your retirement savings, but it does not eliminate the regular income tax you will owe on the withdrawn amount.

A factor determining your ability to withdraw funds is your employment status. Many 401(k) plans have rules that prevent current employees from taking distributions, a feature known as an “in-service” withdrawal, even if they are over age 59½. If you are still working for the company that sponsors your 401(k), you must check your plan’s documents or contact the plan administrator to see if withdrawals are permitted. If you have a 401(k) from a previous employer, you can access those funds without this restriction.

While you can take money out, you are not yet required to do so. The SECURE 2.0 Act raised the age for Required Minimum Distributions (RMDs) to 73 for individuals who turn 72 after December 31, 2022. This means you can allow your funds to remain in the account and continue growing on a tax-deferred basis. If you are still working and are not a 5% owner of the company, you may be able to delay RMDs from your current employer’s plan even longer.

Tax Consequences of Cashing Out

Taking a lump-sum distribution from a traditional 401(k) has substantial tax consequences. The entire amount you withdraw is considered ordinary income by the IRS and is added to your other income for that year. This can increase your total taxable income, potentially pushing you into a much higher marginal tax bracket.

For example, consider a single individual with $60,000 in other taxable income. If this person cashes out a $250,000 401(k), their total taxable income for the year jumps to $310,000. This increase would move them from a 22% marginal tax bracket to the 35% bracket under current federal tax law, meaning a portion of their withdrawal would be taxed at this higher rate.

When you request a lump-sum cash distribution, your plan administrator is required by federal law to withhold 20% of the total amount for taxes. On a $250,000 withdrawal, this means $50,000 is sent directly to the IRS, and you would receive a check for $200,000. This 20% is only a prepayment, not the final amount you will owe. If your total tax liability on your annual tax return is higher than the 20% withheld, you will be required to pay the difference.

In addition to federal taxes, your withdrawal will be subject to state income taxes. State tax rates and rules vary widely, adding another layer to your total tax bill. The combination of federal and state taxes can reduce the net amount you ultimately receive. Cashing out also means you lose the potential for future tax-deferred growth, as the money is no longer invested within a retirement account.

Alternatives to a Full Lump-Sum Withdrawal

Instead of cashing out entirely, several alternatives are available:

• Roll the funds over into an Individual Retirement Arrangement (IRA). A direct rollover to a Traditional IRA is not a taxable event. This allows your money to remain in a tax-deferred account, preserving its growth potential and giving you control over a wider range of investment options.
• Convert to a Roth IRA. This involves paying ordinary income taxes on the entire rollover amount in the current year. Once the funds are in the Roth IRA, all future qualified withdrawals are completely tax-free. This can be advantageous for those who anticipate being in a higher tax bracket in the future.
• Leave your money in your former employer’s 401(k) plan. The benefits include familiarity with the plan’s investments and potentially lower administrative fees. Drawbacks can include limited investment choices and less flexibility for making withdrawals compared to an IRA.
• Take systematic or periodic withdrawals from your 401(k) or a rollover IRA. Instead of taking all the money at once, you can receive a set amount each month or quarter. This approach helps manage your tax bracket each year while allowing the remaining balance to continue growing tax-deferred.

How to Initiate a 401(k) Withdrawal

The first step to access your 401(k) funds is to contact your plan administrator. This is the financial company that manages the plan for your employer, and their contact information is on your account statement or available from your company’s human resources department. The administrator will provide the necessary distribution paperwork and explain your options.

When completing the distribution forms, you will need to provide personal identification details, your Social Security number, and your bank account information for a direct deposit. You will also need to specify how you want to receive the funds, whether as a lump-sum cash payment, a direct rollover to an IRA, or another option.

For married participants, many 401(k) plans require spousal consent to take a distribution in any form other than a specific type of annuity. This rule is designed to protect a spouse’s interest in the retirement asset. If required, your spouse must sign a consent form, which may need to be notarized.

After you submit the required forms, the plan administrator will process your request and send a confirmation notice. The time it takes to receive your funds can vary from a few business days to several weeks, depending on the plan’s procedures and the distribution method selected.