Can I take my 401(k) in a lump sum?
The simple answer is yes. The follow up question is whether a lump-sum withdrawal is a good idea. And the usual answer to that second question is no.
Establishing a retirement savings plan during your working years is a necessary part of comprehensive financial planning. Retirement is one of the most significant financial objectives that you save toward while you earn a living. As employers transition away from traditional defined benefit plans (pensions). the burden of savings now rests on the shoulders of employees. To that end, retirement savings plans that are contribution-based are a common benefit offered to employees, typically in the form of a 401(k) .
The majority of employers and 401(k) plan sponsors provide sufficient direction to employees when they begin contributions to the plan. Some companies automatically enroll eligible workers in a 401(k) plan (they can opt out), while others let employees choose if and when they can participate. Employers often rely on a plan sponsor to educate employees about the benefits and limitations of a 401(k) plan. These sponsors, also known as plan custodians, are also tasked with educating eligible employees about the benefits of the plan, the investment selections available and the contribution limits. However, most employers and plan sponsors fall short of providing beneficial information when employees change jobs, retire or need to take money out of their plans.
Lump-Sum Withdrawal Options
If you currently work for an employer with an active 401(k) plan, you are limited to the lump-sum withdrawal options indicated in the original plan document. The most common lump-sum withdrawal provisions come in the form of a loan against your 401(k) balance or a hardship withdrawal. You repay a 401(k) loan through paycheck deferrals over time. The loan is capped at a certain percentage of your total 401(k) balance, typically 50%.
“If you have a 401(k) plan with the ability to take out a loan, you can withdraw the funds tax free ,” says Kirk Chisholm, a wealth manager at Innovative Advisory Group in Lexington, Mass. “Of course, you will have to pay them back, but this allows you to borrow from your 401(k) account and pay yourself back the interest and principal over time.”
The other option is a hardship withdrawal, a lump-sum withdrawal based on financial need that you do not need to repay. When a 401(k) Hardship Withdrawal Makes Sense will explain the details. Both types of withdrawals may be subject to tax and penalties.
Lump-sum withdrawal options are not as limited when you leave an employer for another job or if you retire. You can take a lump-sum distribution from a previous employer’s 401(k) plan up to the total vested account balance. After placing a distribution request, the plan sponsor or custodian sends a check directly to you, and the account is closed with the custodian. If you have a Roth 401(k) balance, no taxes are withheld; pretax or traditional 401(k) plan sponsors withhold taxes from the balance before cutting the check. In either case, if you are under 59.5, you are subject to a 10% tax penalty for what the IRS considers to be an early withdrawal .
Considerations for Withdrawals
The greatest benefit of taking a lump-sum distribution from your 401(k) plan either at retirement or upon leaving an employer is the ability to access all of your retirement savings at once. The money is not restricted; you can use it however you see fit. You can reinvest it in a broader range of investments than those offered within the 401(k).
Contributions to a 401(k) are tax-deferred; investment growth is not subject to capital gains tax each year. Once a lump-sum distribution is made, you lose the ability to earn on a tax-deferred basis, which could lead to lower investment returns over time.
Having access to your full account balance all at once presents a much greater temptation to spend. It can be a challenge to implement self control, which may result in running out of money in retirement .
Tax withholding on pretax 401(k) balances may not be enough to cover your total tax liability in the year when you receive your distribution, depending on your income tax bracket. A large tax bill further eats away at the lump sum you receive. See How to Minimize Taxes on 401(k) Withdrawals .