Can I Withdraw From My 401k? You Might Have Better Options

Switching jobs can have its perks—new opportunities often mean new experiences, an expanding skill set, and perhaps an enticing salary and benefits package. And with the benefits of a new job comes a very important question: What should you do with your old 401(k)?

Pros and cons of cashing out

If you’ve contributed to a former employer’s 401(k), it may sound appealing to use your assets to pay off debt or fund an upcoming purchase like a down payment on a car or home. However, the long-term impact of cashing out your 401(k) can be quite significant.  

Fees, taxes, and penalties can considerably reduce the amount of money you’ll receive from cashing out your 401(k). The amount you cash out will be subject to a mandatory 20% withholding for federal income tax, and there is an additional 10% early withdrawal penalty if you’re younger than 59 ½. You may also be responsible for ordinary income tax on the full amount of your distribution as well as state and local taxes, depending on where you live. 

More importantly, a benefit of a tax-advantaged 401(k) account is that it allows your pretax contributions to continue growing tax-deferred. Over time, your earnings can generate their own earnings, potentially helping you accumulate even more. Alternatively, if you cash out your 401(k), you can’t make up for the power of earnings lost over time.

But there are alternatives to cashing out that can help keep your retirement plan going, and potentially growing, over time.

Alternatives to cashing out

Determining what to do with your old 401(k) is an important financial decision you may need to make many times in your career. And you’ll want to carefully consider all your choices, including not just cashing out but also the ones that may help your account continue to grow. These choices are leave it with your former employer, roll it into your current employer’s plan, or roll it over to an individual retirement account (IRA). Please visit tdameritrade.com/rollover for more information on rollover alternatives.  

When considering the choices available to you, it’s important to understand the impact each choice has on your investment. Questions to ask yourself as you go through this process might include:

• What fees are involved in rolling over the account?
• What range of investment choices does your new employer’s 401(k) offer? Are these investment choices suitable for your goals?
• How much flexibility does the new employer’s plan give you to choose and manage investments?
• What are the potential penalties if you were to withdraw money early from the 401(k) or IRA you choose?

After asking these initial questions, refer to the information below and visit the TD Ameritrade Rollover IRA page for a more complete list of advantages and disadvantages regarding each choice.

Leave it where it is

Some employers will let you keep your 401(k) where it is when you leave, and this may be a solid alternative to cashing out. Your old plan might offer low-fee products, and despite any administrative fees you may be assessed, your old plan may still be your lowest-fee alternative.

Though your funds can continue to grow tax-deferred, you won’t be able to contribute additional funds going forward, and you’ll be limited to the investment choices the plan offers. Plus, as a former employee, you may be subject to certain administrative or record-keeping fees (you should check with your former employer).

Roll over 401(k) to an IRA

This involves taking your old 401(k) plan and “rolling it over” either into your new employer’s plan (if your new employer allows that) or into an IRA. In both cases, you’ll be able to continue making contributions and your funds can grow tax-deferred, but after that, these choices differ.

Rolling your 401(k) into a new employer’s plan lets you consolidate your old and new 401(k) savings in one place. Your investment choices will be limited to only those offered in the new plan, but again, your new employer may have access to some low-fee investments that you might not get on your own. You also may be able to take advantage of advisory products or services that will manage your investments for a fee. You may also be able to take loans against your account, if needed. While employers do not generally provide a match to money rolled into the plan, your new employer may offer a match to your other contributions.

If you choose to roll over to an IRA, you’ll generally have access to a wider variety of investment vehicles (like individual stocks, bonds, mutual funds, ETFs, and options), giving you more flexibility to construct your own portfolio that aligns with your investment objectives. You also may be able to take advantage of advisory products or services that will manage your investments for a fee. You can’t take a loan against an IRA, though you may be able to take penalty-free withdrawals in certain cases to cover education, health insurance premiums, or a first-time home purchase.

Read the fine print

If cashing out seems like a necessity due to expenses, you may also want to look at the specific rules of both your old and new employer’s plans. For example, some plans allow for penalty-free withdrawals for certain expenses. Allowable withdrawals added or clarified for 2023 under the SECURE Act of 2022 include:

• Withdrawals to support birth or adoption costs: Individuals can make penalty-free withdrawals from 401(k)s and IRAs to help offset costs related to having or adopting a child—up to $5,000 per adoption or birth. But workers now have three years to pay it back if they choose to do so.
• Penalty-free withdrawals—terminal illness: For those certified by a physician as having a terminal illness that could result in death in seven years or less, withdrawals from 401(k)s and IRAs can be made without the 10% penalty. (Note: There is no requirement to repay a Terminal Illness withdrawal, though if the employee chooses to repay it, they must do so within three years.)
• Hardship withdrawals—federally declared disaster: For federally declared disasters on or after January 26, 2021, if an individual lives in a federal disaster area and suffers an economic loss in connection with it, they can make a 401(k) plan or IRA withdrawal up to $22,000 within 180 days after the disaster without the 10% early withdrawal penalty. They have the opportunity to repay the amount within three years of withdrawal. Note: If this is an employer-qualified plan like a 401(k), the plan may require an amendment or that the employee meet a reason for in-service withdrawal to access their funds.

And starting in 2024, penalty-free withdrawals will be permitted for victims of domestic abuse, thanks to the 2022 SECURE Act. Also in 2024, emergency withdrawals get a boost. Individuals will now be able to withdraw up to $1,000 per year from a 401(k) plan penalty-free for emergency expenses and will have the flexibility to repay within three years.

Also, if you separate from your employer during the year you reach age 55 (or older), you might be able to take penalty-free withdrawals if you stay in your plan (although distributions will still be subject to regular taxes). And some plans allow you to borrow from your account, usually with the requirement that you pay yourself back, with interest that is. Knowing the details may help you choose an alternative that helps preserve your 401(k) savings while helping address the need for cash. 

With all the possibilities available for your old 401(k), you should consider talking to an accountant or tax advisor before taking action so you can better understand any tax implications. And as you progress through your career, make sure you continue to consider choices for your old 401(k)s that help you make the most of your savings.