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I realize that if I "cashed out" on a 401K early, I end up having to pay taxes on the cashed out 401K savings. But, I would have had to pay taxes on that 401K amount if I had not put into savings anyway.

In addition, say my company matches up to 5% of my 401K. Then I put in up to 5% of my earnings into the 401K, and the company matches. I do this for a few years, and then withdraw the full amount in the savings.

I do get taxed on the entire amount, but I've gotten an additional 5% (minus taxes) in addition to my salary base. Is my understanding correct? Is there anything I'm missing here?

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    You can't withdraw usually unless you leave the company. Often times it depends on company policy and has to be approved. If you leave, you can withdraw whenever you want with a penalty in both cases. You can, however, usually take a loan up to half the vested amount. This is not taxed and you pay it back via your pay check. It also does not go on your credit report.
    – Engineer2021
    Commented Jul 2, 2014 at 12:08

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All the money you take out of your 401(k) is counted as Ordinary Income in the year in which you take it out. The fact that some of the money came from your own salary and some was "company matching" is irrelevant.

Also, as another contributor mentioned, you will penalized for withdrawals which occur before the age of 59 and a half. So if you are younger than that - don't take that money out unless you REALLY REALLY need it.

If you simply want to move your money out of the accounts they are currently in, or you don't like the company that is currently managing it, look into a "401(k) rollover."

Additionally, under certain circumstances, you may use the money in the purchase of a first home, without incurring a penalty. The money is still taxed, but you don't pay the 10%. If you are thinking about this option, talk to your mortgage lender. (The details are beyond the scope of this brief answer.)

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  • "All the money you take out of your 401(k) is counted as Ordinary Income in the year in which you take it out." Assuming it's not a Roth 401k.
    – user102008
    Commented Jul 2, 2014 at 6:46
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    True, but I assumed this would have been mentioned in the original post, given that Roth 401(k)s are still a little unusual (and so worth noting) and the question specifically asked about taxes on withdrawal.
    – Adam Michael Wood
    Commented Jul 2, 2014 at 6:49
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From 401K Withdrawals on About.com:

With rare exceptions, all 401K withdrawals are taxable as ordinary income. An additional 10% early distribution penalty tax will be assessed if you have not reached at least age 59 ½ when you take your distribution.

So, consider this extra penalty that may apply in some cases.

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    +1 - Also, you lose the tax-deferred compounding of the account over many years. This is no small thing.
    – Rick Goldstein
    Commented Jul 1, 2014 at 20:44
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    Remember. If you separate from employment at 55 or older, no penalty for withdrawals, just tax.
    – JTP - Apologise to Monica ♦
    Commented Jul 1, 2014 at 22:52
  • Note that this penalty only applies to the part of the distribution that is taxable, which, if this is a Roth 401k, may not be the whole distribution.
    – user102008
    Commented Jul 2, 2014 at 6:46
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Simple math. You are in the 25% bracket. Deposit $2000, you are $1500 out of pocket. You have $4000 after match. You leave company, pay $1000 tax, $400 penalty, netting $2600.

Say the match vests over 4 years. After one year, you have $2500. $625 tax and $250 penalty leaves $1625. Still more than your $1500 deposit. Obviously, before any match hits, you're at a disadvantage.

As two others stated, a bad idea, don't withdraw. But the math is why I say to never miss the match.

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  • You might also have to wait a few years to be fully vested in the company contributions.
    – mhoran_psprep
    Commented Jul 1, 2014 at 23:15
  • Edited to add vesting to answer.
    – JTP - Apologise to Monica ♦
    Commented Jul 2, 2014 at 1:45
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    You can take a loan and not take any penalities. It is paid back in a set amount of time (usually 5 years or less) and you earn interest on the money you pay back. My company offers a 10 year loan when buying a house for 401k withdrawals. The money is paid back in your paycheck. If you leave the company before it is paid back, then the remaining amount is taxed as income if you don't pay it back before leaving the company. You are then given a 1099 to file with the IRS during tax season.
    – Engineer2021
    Commented Jul 2, 2014 at 12:10

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