What Are the Pros and Cons of Cashing out a 401k?

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  • Written By: Luke Arthur
  • Edited By: Heather Bailey
  • Last Modified Date: 18 May 2020
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One of the advantages of cashing out a 401k is being able to gain access to a large sum of money at once. Another advantage of cashing out a 401k is that an individual can use the money as he or she sees fit. Even though cashing out the fund can provide access to money, this process has several disadvantages, such as having to pay an early distribution penalty. In addition, an individual will have to pay income taxes on the money that is received.

Many individuals cash out a 401k because it allows them to get access to an amount of money that has been saved for many years. In most cases, a 401k account is contributed to by an employee and an employer for several years. By doing this, the account can often reach large amounts of money in a short amount of time. When an individual cashes this account out, he or she could have a large sum of money at his or her disposal.

Another advantage of this procedure is there are no restrictions on what the money can be used for. After an individual cashes out the 401k, the money is free to be used for anything. This means an individual could use the money to buy new furniture, make an investment, or do anything else.

One of the biggest disadvantages of cashing out a 401k is the individual will have to pay an early distribution penalty. This penalty amounts to 10% of the amount of money that is withdrawn from the account. If the account balance is substantial, this could amount to a very large penalty that has to be paid. The penalty will be paid when the individual files his or her income taxes for the year.

Another disadvantage of cashing out a 401k is that the money will be counted as regular income. This money is going to increase the income of the individual and he or she will have to pay income taxes on the amount that is withdrawn. In some cases, if the distribution is substantial, it could put the individual into a higher tax bracket for the year. This means the individual would have to pay income taxes at a higher rate on the rest of his or her income, which could significantly increase the amount of taxes paid for the year.

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