How Much Money Is Lost When Cashing in a 401(k)?

When you cash in your 401k, the funds you actually receive typically amount to less than the closing 401k balance. Taxes, mutual fund redemption fees and custodian fees often reduce a lump sum withdrawal by more than 30 percent. You can delay the tax penalties by transferring your 401k balance into another tax-sheltered account, but other fees are unavoidable.

Income Tax

Your contributions to your 401k account are made pre-tax as are matching contributions by your employer. The funds invested grow inside the 401k without being exposed to federal or state taxes. However, when you cash in your 401k, the Internal Revenue Service adds the amount withdrawn to your ordinary income for the year in which you access the funds. You must pay income tax on the entire amount unless you directly transfer the proceeds to another tax-deferred retirement account such as an individual retirement account.

Premature Withdrawal

When you cash in your 401k, if you decide not to transfer the proceeds to an IRA, you may also have to pay a 10 percent early withdrawal penalty in addition to ordinary federal and state income tax. The Internal Revenue Service assesses a flat 10 percent penalty tax on any 401k withdrawals that occur prior to the year in which you turn 59 1/2. Someone in a high tax bracket could lose almost 50 percent of a 401k withdrawal amount as a result of federal income tax, state tax and the premature withdrawal penalty. There are some exceptions to this rule, however.

Redemption Fees

Funds held inside a 401k account are typically invested in mutual funds. Funds charge fees known as loads when you buy or sell shares. Therefore you may have pay a load when you cash in your 401k mutual funds. Some "no-load" funds do not charge a transaction-based commission but instead charge a flat fee any time you sell shares. These fees are paid from the 401k proceeds. You can find out what fees are due by reviewing your 401k prospectus or asking your account custodian.

Processing Fees

Employers hire financial firms to act as custodians of 401k accounts, and these firms make money by charging fees for managing your account. Custodians usually charge annual fees for managing your money but can also charge fees any time you make changes to your or account or sell your funds. Additionally, if you are concerned about the safety of a 401k custodian mailing you a large check for the remaining proceeds, you can request to have proceeds sent by overnight delivery or wired to your bank account. However, you must pay a fee to have you funds sent by any method other than regular mail and these fees further reduce your payout amount.

References

• Internal Revenue Service: Topic 424 - 401(k) Plans
• Kiplinger: Shedding Light on 401(k) Fees; Anne Kates Smith; 2007
• Internal Revenue Service: 401(k) Resource Guide - Plan Participants - Limitation on Elective Deferrals
• Kiplinger: The High Cost of 401(k) Fees: How Much Are You Paying?; Mary Beth Franklin; 2008

Resources

• Internal Revenue Service: 401(k) Resource Guide