Laid off from work, cashing out my 401k

June 19, 2013 9:59 PM

Hey everyone, I read some other threads in regards to 401k but it seems like the audience is divided. My recent company (industry giant who laid off 8000 employees and gave our jobs to folks in India) has laid me off and I need to cash out my 401k. I am wondering who has experience with this as of the past year or two? I live in Mass so Fidelity says I will have to take out 20% out of my total sum for taxes but they didn't say anything about a penalty. My amount is less than $11,000 and I want to use some of it to start my own agency. Has anyone cashed out their 401k and if so, was there a penalty? PS. Please spare me the 'noo dont cash out, its a bad idea' -- I'm knee deep in $115k for student loans and my life could not get worse and more complicated so I'm confident cashing this crap out is my only way out to some sanity and inner peace. Thanks!
posted by bostonhill to Work & Money (16 answers total)

I cashed mine out last year. There was a penalty (federal), but I don't recall what it was.
posted by LionIndex at 10:05 PM on June 19, 2013

I cashed one out about three years ago in similar circumstances and got about $5000 of $7000 out of it. If I remember the details, the 20% is the penalty, but then you also have to claim the distribution on your taxes for the year. Which, if you are unemployed, may not make much difference either way.
posted by restless_nomad at 10:32 PM on June 19, 2013 [2 favorites]

You might look into getting a loan off the 401k, although I'm not sure about availability when you are unemployed.

Apply online through the Fidelity website. This is what I did. The loan max was half of my 401k savings. The terms for paying it back are VERY good. Can't remember the interest rate, but I think it was either 3% or 5%. You can stretch payments out for 5 years, with an option to pay off early at any time. There are no penalties or tax liabilities in this case.

If you can find time, please post what you actually did and results. I've got a Fidelity 401k too, and am interested in what you learn.
posted by ErikH2000 at 10:42 PM on June 19, 2013

I think I actually had the option of having the 20% deducted from the disbursement, or I could have just worked out the disbursement with the rest of my taxes, so I think the 20% is something different.
posted by LionIndex at 10:43 PM on June 19, 2013

Do NOT get a loan on the 401K... first, you probably can't because you're laid off. Second problem is that if you do have a loan, you MUST pay it off in full if you leave the company.
posted by drhydro at 11:23 PM on June 19, 2013 [1 favorite]

I cashed mine out (around US$60k) in three stages over three years. I believe the key is to cash it out during years in which you have no other taxable income. IIRC, I had to pay the feds 10% penalty each year for the amount I withdrew. The "dreaded huge tax hit" that the scare mongers always talk about was no big deal for me because I had no other wages during that time, so my federal taxes were extremely small. I guess I was "lucky" to cash it out while I had no other income. The only real penalty I had was the 10% off the top.

I think the huge tax hit happens when you cash it out in one lump sum while also earning a decent wage income. It can bump you up a tax bracket or two which can eat a lot out of the cash-out value when combined with the 10% penalty.

nb: I did this from 2003-2006 so I was able to keep my 401(k) money for myself when the economic crash hit in 2008 or so. (F.U. Wall Street!) I'm never going to take part in a 401(k) ever again. Too many restrictions. I'll live frugally and save a part of my after tax income to fund my own retirement. I believe the system (no matter where you turn) is rigged against us little folks.

YMMV, this is not tax advice, please seek a knowledgeable and well trained professional before making any decisions. Best of luck!
posted by InsertNiftyNameHere at 2:03 AM on June 20, 2013 [2 favorites]

10k in a 401k now is worth multiples of that in 25 years. Instead you want to take a 20+% hit to clear 8k or so with over 100k in debt, toward which the 8k will make almost no difference. And I'm not so sure you can start any sort of business for $8k that will replace a full time job.

I know you don't want to hear it, but you'd be better off finding any other job, negotiating forbearance on the debt, or discharging whatever debt you can through bankruptcy. The 8k will be gone in a few months at best, when it might have grown to a year's worth of retirement income, depending on your age and investments. Given the size of your student loan debt, I'm guessing you are young.

On the other hand it does give you time to regroup. But 10k at 5% interest for 40 years compounded tax free? That's over $50,000 if my math ain't totally screwed. Even adjusting for inflation, presuming historical trends, that's a big trade off for $8k now.

It really is pissing money away unless you have no other possible solution. You can get loans deferred by unemployment and presumably you get unemployment benefits for some period of time. Use that to find a new job.
posted by spitbull at 2:05 AM on June 20, 2013 [10 favorites]

8k will pay your rent and basic living expenses for a few months at best. You can't start a business with that. If you could knock out your debt mostly or entirely with it, it might be worth considering, but you'd really, really be better off just finding another job, ASAP.
posted by empath at 2:49 AM on June 20, 2013 [2 favorites]

The "huge tax hit" is paying taxes at all on retirement savings at your current income tax rate. If that rate drops to nothing, it's still a 20% penalty, which is a huge tax hit compared to "tax free until retirement." But the biggest hit by far for a young person is the loss of decades of compounding earnings on a relatively small initial investment.

No one who can do math would cash out a 401K without exhausting every other possible option.
posted by spitbull at 3:07 AM on June 20, 2013 [1 favorite]

When you file your taxes, you will have to include the entire amount you withdraw (not just the gains) in your taxable income. In addition, you will have to pay a penalty of 10% of the withdrawal.

If that amount is less than the 20% withheld (possible if your income for the year, including the withdrawal, is low) you will get some of it back. If it's more, you will owe the additional tax and penalty at tax time.
posted by payoto at 4:35 AM on June 20, 2013

You pay your regular taxes on it, then you pay a 10% penalty. You'll claim this on your 2013 1040.

FYI, rather than start your agency, sign up for unemployment NOW. Then look for a job.

If you don't, and your agency doesn't do anything, you're out your 401(k) AND you won't be able to claim unemployment.

You can always freelance while on unemployment.
posted by Ruthless Bunny at 6:09 AM on June 20, 2013 [3 favorites]

Mod note: Comment deleted. Folks need to be answering the question rather than chatting generally about 401Ks, and if you'd like to talk to another commenter in the thread, the best way to do that is mefi mail or email. Thanks.
posted by taz (staff) at 6:24 AM on June 20, 2013

I don't think it's been stated super clearly yet. The 20% is a general federal withholding. If your tax bracket is higher than 20%, you'll still owe more at the end of the year, plus state taxes. On top of federal and state taxes, you'll owe a 10% penalty. If your tax bracket is less than 20%, you'll get a refund.

A 401(k) withdrawal is just like getting a paycheck, subject to all the same taxes since you didn't pay those taxes when it went into your account.
posted by hwyengr at 6:31 AM on June 20, 2013 [3 favorites]

Regular federal taxes (taken as that 20% and adjusted at tax filing time), plus state, city, local taxes, plus 10% PENALTY that has nothing to do with taxes. I'm in Oregon, and when I did this, I got $6000 out of a $9,900 balance.
posted by peep at 8:24 AM on June 20, 2013 [1 favorite]

hwyenger is right. When I looked at doing this, I discovered that I would only clear about $9000 of the $17,000 I have in the retirement account at issue. The $8000 I would lose would go to pay the 10% penalty for early withdrawal, plus taxes on the total, at my normal marginal federal tax rate and at my state income tax rate. Chances are I'd've gotten some of that back in my tax refund, since my effective tax rate is lower than my marginal tax rate, but that's neither here nor there -- I'd still have been out a hefty chunk of change on the total, money I worked for and that came out of my paycheck, that I would NEVER SEE AGAIN.
posted by devinemissk at 9:09 AM on June 20, 2013

You might look into Income-Based Repayment for your loans, too.
posted by Riverine at 12:51 PM on June 21, 2013