Factors to Consider Before Cashing Out Your 401(k)

Before cashing out your 401(k) for immediate funds, consider the potential long-term consequences. In this blog, we’ll discuss important factors to consider regarding your retirement savings and what you need to know to make informed decisions.

You know the goal of your 401(k) plan is to save. But while you’ve been working hard to contribute part of your salary, life may get in the way. However, cashing out your 401(k) is a heavy decision and shouldn’t be made lightly – but it may be necessary. Here’s what you need to know if you are considering cashing out a 401(k).

401(k) Plans 101

An employer-sponsored 401(k) plan encourages you to save for retirement by allowing pre-tax contributions from your paycheck and tax-deferred growth on your investments. The downside is that you can’t withdraw the money before you turn 59½ years old unless you are experiencing a serious financial hardship or are willing to incur a 10% penalty — and both options have additional consequences you need to consider before making an early withdrawal.

Hoping to get a penalty-free early 401(k) withdrawal as part of the federal government’s COVID-19 relief efforts? Unfortunately, that’s no longer valid. A program implemented during the early days of the pandemic allowed people younger than 59½ to take up to $100,000 from their retirement accounts without the usual 10% penalty. But that program was discontinued in 2021.

If you’ve explored all other options and still feel like you need to access your 401(k) funds and cash out, there are ways to do so without a penalty. Which we will discuss later.

What the Data Shows

Saving for retirement requires looking at the big picture, but it can be dispiriting when your 401(k) or other retirement plan takes a beating — a common plight for American workers last year.

The average balance in a 401(k) plan tumbled 20.5% in 2022, reducing employee nest eggs to $103,900 at the end of 2022, according to new data. That compares with an average balance of $130,700 a year earlier, citing an analysis of 22 million retirement plan participants.

Not surprisingly, anxiety about having enough money socked away for your golden years are also on the rise, with Americans stressed over their declining balances and rising inflation. One recent study found that workers now anticipate needing $1.25 million for a more comfortable retirement — a hefty 20% jump from 2021. Despite the data, Americans continue to put money in their 401(k)s. The contribution rate held relatively steady at 13.7% last year, and about one-third of workers increased how much they put away.

If you are considering making an early withdrawal from your 401(k), your first step is to find out if your plan allows one. Not all plans do. Taking money out of your 401(k) retirement plan early might sound better than borrowing money or putting a large expense on a credit card. But if you cash out your 401(k) or access your funds before you reach the age of 59 1/2, you will likely face a 10% early withdrawal penalty on the sum you took out. What that means is if you take out $5,000 at age 48, you’ll lose $500 as a penalty, and you’ll pay personal income tax on the whole $5,000.

Long-Term Drawbacks of Withdrawing From Your 401(k) Early

Because 401(k)s are set up as retirement plans, cashing out early can set you back considerably. You will have less money now because of the penalty and tax, and you’ll lose even more over the long term because your money will not have the opportunity to grow or be matched by your employer in the years until you retire.

Waiting to cash out your 401(k) during times of volatility may give your account time to recover and help protect your nest egg. It’s essential to assess and prioritize your retirement savings strategies to help ensure a comfortable retirement, even during economic uncertainty. 

Tips for Withdrawing From Your 401(k) Effectively

When you are ready to withdraw funds from your 401(k), you still want to be strategic. Follow these pointers:

  • After you’ve left your job, wait until after 59 1/2 to withdraw money from your 401(k).
  • If you’re withdrawing early, ensure your situation qualifies for a penalty-free exception.
  • Don’t leave your job until you turn 55 to withdraw money without penalty.
  • If you want to withdraw early, determine if you qualify for penalty-free distributions under rule 72(t) from the IRS, which requires you to take equal periodic payments for at least five years until you’re at least 59 1/2.
  • Consider reinvesting 401(k) withdrawals in an annuity.

Alternative Considerations

There may be a few reasons why you would consider withdrawing from your 401(k). The simplest answer may be that you’re in retirement. Other reasons include urgent medical expenses, burial costs, or other immediate needs that you can’t avoid. In such cases, it may be necessary to cash out your 401(k) – despite the financial consequences. But before doing so, consider these five factors:

1. Cash Flow

To achieve a comfortable retirement, it’s essential to consider your cash flow needs carefully. A preliminary estimate of your retirement expenses is often based on your current spending patterns. However, as you enter retirement, your cash flow needs may change, and unexpected life events could arise. As such, it’s recommended that you evaluate your cash flow periodically before and after retirement to adjust your withdrawal amounts accordingly.

Working with a retirement income advisor is essential in assessing your retirement plan’s cash flow needs. Your Fiduciary advisor can help you help determine the appropriate withdrawal rate and make adjustments to reflect any significant life changes, such as a change in health status or a new grandchild. By doing so, you can help ensure that you have sufficient income to support your lifestyle throughout retirement.

2. Risk Tolerance

The plummeting value of retirement and brokerage accounts can cause concern and worry for some investors. If you’re losing sleep over the market downturn, you may want to consider reducing the risk level in your portfolio with the help of a Fiduciary advisor. It’s important to remember that doing so may mean sacrificing higher returns associated with growth-oriented investments.

Conversely, you can choose to maintain your portfolio’s risk level and asset mix but withdraw less from your retirement accounts during market downturns to maintain your assets over the long term. Contrarily, during market upswings, you could increase your withdrawal amounts if desired. Working with a trusted Fiduciary advisor can help you determine the best course of action to achieve your retirement goals based on your risk tolerance, cash flow needs, and long-term objectives.

3. Longevity

Contemplating how long we will live is not something many of us feel comfortable doing. Even so, to determine the amount of your annual retirement account withdrawal, it’s essential to estimate, as accurately as possible, how many years your money needs to last. According to the CDC, the average life expectancy in 2021 for men was 73.5. That figure increases to age 79.4 for women.

Consider these averages a starting point only. You’ll also want to factor in the health and longevity of your nearest family members when gauging your lifespan. If your mother and father lived into their 80s, that’s an indicator you may, as well. Online calculators are another helpful tool in arriving at an accurate life expectancy estimate. Ultimately, it’s a good idea to err on the side of caution and assume you’ll live longer than expected.

4. HealthCare

Healthcare expenses tend to increase in retirement, particularly during the later years. This can be attributed to longer life spans and rising healthcare costs. As individuals age, the likelihood of requiring long-term care also increases, with seven out of ten people expected to need it at some point in their lifetime.

It’s crucial to factor in these healthcare expenses when planning for retirement, as they can have a significant impact on your retirement savings. By estimating these costs and creating a plan to cover them, you can help avoid any financial surprises in retirement.

One approach is to consider purchasing long-term care insurance to help offset the cost of future medical expenses. Additionally, working with a Fiduciary advisor to create a complete retirement plan that accounts for healthcare expenses can help ensure that your retirement savings will last throughout your lifetime.

5. Taxes

You’ll also want to keep an eye on the impact of taxes on your retirement accounts. It matters which retirement account you withdraw from first. Implementing tax-efficient retirement withdrawals can make your savings last longer. Just as your portfolio is diversified with a mix of stocks, bonds, and other investments, your retirement assets should also be diversified. 

Here are some tax-deferred accounts that you can utilize:

  • 401(k)s and 403(b)s
  • After-tax accounts like Roth IRAs and Roth 401(k)s
  • Taxable brokerage accounts. 

Working with your Fiduciary advisor can help you create a withdrawal-sequencing strategy to help minimize the taxes you’ll owe on your account distributions. It’s important to note that if you are 73 or older and have to take a required minimum distribution (RMDs)  from certain accounts, that becomes part of your overall withdrawal strategy.

Consult With Your Fiduciary Advisor 

Cashing out your 401(k) can have significant long-term consequences, so it’s crucial to consider all factors carefully. At Johnson Wealth and Income Management, we’re committed to helping you achieve your financial goals and enjoy a worry-free retirement.

Our experienced retirement income advisors offer a range of services and knowledge to help you make informed decisions about your retirement savings, including when to withdraw your 401(k) savings. 

Contact us today to learn more about how we can help you plan for a more secure and comfortable retirement.


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