How much is penalty for cashing out 401k

U.S. Senate Majority Leader Mitch McConnell (R-KY) arrives at the U.S. Capitol on March 18, 2020 in Washington, DC. McConnell is urging members of the Senate to pass as soon as possible a second COVID-19 funding bill already passed by the House.

Win McNamee | Getty Images

You soon should be able to withdraw up to $100,000 from your 401(k) retirement plan amid the coronavirus outbreak.

Just make sure you read the fine print before you do.

The Senate has approved a package of COVID-19 stimulus measures, one of which allows savers to take emergency withdrawals – known as hardship distributions – of up to $100,000 from their retirement plans. It now moves to the House where passage is expected.

Savers under age 59½ would be able to tap their 401(k) and 403(b) money without the usual 10% early withdrawal penalty. This would also apply to individual retirement accounts.

The legislation also would issue families rebate checks of $1,200 per individual and $500 per child, as well as suspend payroll taxes for employers.

However, before you access that cash, proceed with caution. You may be doing more harm than good.

"People play up the relief like it's a freebie," said Ed Slott, CPA and founder of Ed Slott & Co. in Rockville Centre, N.Y. "You're better off using anything else before using your retirement savings."

The devil in the details

Normally, if you were to take money from your retirement plan, you would be subject to a 10% penalty if you're under age 59½, along with income taxes on the amount you're withdrawing.

The relief bill gives you the opportunity to pay the taxes over the course of three years. You can also replenish the amount that you pulled from your retirement account over that time.

These distributions may be taken by people who themselves are diagnosed with coronavirus, or whose spouse or dependent has been diagnosed with COVID-19, or who experience adverse financial consequences from being quarantined, laid off or furloughed.

3 reasons to proceed with caution

by Schneider-Photographie

Experts suggest moving slowly with any withdrawal. Here are three things to consider.

Hardship withdrawals are still subject to income taxes. Since your savings went into your retirement plan on a pretax basis, you'll be paying income taxes on the contributions and earnings withdrawn.

"You get a three-year period to pay the taxes to Uncle Sam," said Paul Porretta, partner at Pepper Hamilton LLP in New York.

Plan ahead to cover the tax bill and spread it over that period of time, perhaps out of your cash flow.

Know your 401(k) plan's rules. Be aware that a workplace retirement plan may allow hardship distributions from participants' savings, but it isn't required to do so.

You'll need to talk to your human resources department or your plan administrator before you proceed.

"A 401(k) plan or a 403(b) plan, even if it allows for hardship withdrawals, can require that the employee exhaust other sources of money before taking a withdrawal," said Porretta.

For instance, a plan could require that you take a loan from your 401(k) savings before allowing you to take the hardship withdrawal.

Plan loans are subject to a different set of rules altogether. You can take them free of taxes if you meet certain requirements. Normally, you can borrow up to 50% of your vested account balance or $50,000, whichever is less.

The Senate bill also doubles the amount you can borrow: $100,000.

Generally, if you lose your job with a 401(k) loan on the books, the amount borrowed is treated like a withdrawal and you're on the hook for taxes.

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Make it your last resort. If you took money out of your retirement plan now, you'd be doing it at the worst possible time: Cashing in when stock prices have been plummeting.

Consider other potential sources of money before you raid your retirement savings, including your emergency fund.

For instance, a home equity line of credit, if you already have one open, can act as an emergency lifeline if you're staring down the prospect of a layoff.

"It's too easy to take money from your 401(k), and it's too hard to replace," said Slott. "What if you need more money in six months? Are you going to go back to the well again?"

Can I close my 401k and take the money?

Is cashing out 401k worth it?