Can I Cancel My 401K and Cash Out While Still Employed?

Money saved in a 401(k) plan has multiple benefits, often growing unnoticed through pre-tax payroll deductions and employer matches.

It can be a comfort to see just how much you save in a 401(k) year-to-year, but those savings can also be a temptation when unexpected issues leave you in serious financial binds.

If you’re facing an economic or health crisis, or have significant debt, you might be tempted to take money out of your 401(k) early or even close the account.

Taking out at least some of that money is do-able, but only under certain circumstances that aren’t easy and are costly. Cashing out all of it and closing the account altogether while you’re still employed by your plan’s sponsor is even more problematic, especially if you don’t meet those certain circumstances. In many cases, you simply can’t.

Why? Because the IRS created 401(k) plans to provide savings for your retirement. It doesn’t want you to jeopardize that.

Either way – taking early withdrawals or cashing out before retirement age — financial planners typically agree: “Don’t do it!”

Should You Withdraw from Your 401k Early?

The penalties for early withdrawal, even if you plan to put it back in, far exceed any benefit you may think you’ll gain.

“Borrowing from a 401(k) can be a tempting option because it provides access to funds quickly and without a credit check,” Andrew Latham, a certified financial planner, and Managing Editor at SuperMoney.com, said. “However, borrowing from your 401(k) should be considered carefully due to the potential impact on your long-term retirement savings.”

The federal government temporarily removed penalties for early withdrawal during Covid-19, but the CARES Act that allowed it has expired. Even then, taking money out of a 401(k) had major downsides.

A 401(k) account is a vital part of your future. It’s your pot of gold at the end of the rainbow (retirement). There are two good reasons not to toy with it even during a national crisis:

• The value of stocks and mutual funds typically plummet during a crisis. Your investment might already have lost significant value during a market downturn, meaning you already have significantly less money from which to borrow.
• Less money in the account means you definitely will lose out on gains from compounding interest that make long-term investing so attractive.

Can I Withdraw from My 401(k) Early?

When the alternatives to making an early withdrawal aren’t available to you – personal loans, home equity loans, using funds from a Roth IRA – it’s possible to dip into your 401(k) … but only if you meet certain requirements.

You should first consult a financial planner and your plan provider to understand the rules and ramifications of an early 401(k) withdrawal:

• The IRS levies a 10% penalty on all non-exempt withdrawals before the age of 59 ½.
• Since pre-tax money funded your 401(k) account, your withdrawal is taxed.
• The money you withdraw stops working for you.

Latham uses the example of a 35-year-old who takes $5,000 from a 401(k) to deal with an unexpected financial burden.

“The true cost isn’t just the $5,000,” he said. “It’s the lost opportunity for that money to grow over time. Assuming an average annual return of 7%, by the time you reach 60, that $5,000 could have grown to approximately $27,140.”

Common 401(k) Questions

We mentioned earlier that one of the benefits of a 401(k) is that your retirement money can grow even when you aren’t paying much attention to it, thanks to employer matches and payroll deductions. But that doesn’t mean you shouldn’t be familiar with how your 401(k) works.

Here are some frequently asked questions and answers, including some details about 401(k) loans, which might help you with decisions about your retirement savings.

Why should I be bothering with a 401(k) in the first place?

It’s one of the easier ways to save money, especially if you do it by payroll deduction and your employer matches some of your contributions. Beyond that, there are decided income tax advantages during your working years.

How much can I put into my 401(k)?

The IRS sets the limit. In 2025, that limit is $23,500 per year if you’re under 50. If you’re older than 50, you’re allowed to put in an additional $7,500 in annual catch-up contributions.

How does my 401(k) money grow?

In addition to payroll deductions and employer matching contributions, your 401(k) savings are invested by the plan and can grow that way. Most plans allow you to choose how you want that money to be used, meaning you have some say about how much risk you want to take with the money you invest.

How are my 401(k) savings taxed?

They’re tax-deferred, which means they aren’t taxed at all until you start to use them. In other words, the government doesn’t consider your 401(k) contributions (and interest they earn) as income for as long as you don’t touch that money. That cuts into your tax liability while you continue to work.

What’s the difference between a 401(k) and a Roth 401(k)?

In a Roth 401(k), your contributions are taxed on the front end, when they’re made. There is no tax levied when you withdraw from a Roth 401(k) upon retirement, as there is with a traditional 401(k).

Can I borrow money against my 401(k) funds while I’m still working?

Check your plan’s rules. Most allow it, though restrictions and potential penalties come into play. When you do it, you’re borrowing your own money, so you’re essentially the lender as well as the borrower. You’ll pay interest on the loan you take from your 401(k), but you’re paying that interest back to yourself. Be aware, though, that some plans only allow you to borrow from your 401(k) for certain reasons, such as buying a house or paying a dependent’s college tuition.

It’s my own money, right? So why would I have to pay interest on a 401(k) loan?

The government authorizes 401(k) plans, so it gets to make that rule even while your employer is the plan’s sponsor. The IRS insists that a 401(k) loan must be paid back with interest and within a specific time frame (usually five years) just like any other loan. Here’s an upside: You aren’t paying that interest to the government or a bank; you pay it to yourself. But here’s a downside: You lose the tax-deferred benefit. The government taxes the interest you pay to yourself when you’re satisfying a 401(k) loan, and taxes it again when you withdraw your 401(k) funds during retirement.

Is it at least a decent interest rate?

That depends on your perspective and your alternatives. It’ll be 1 to 2 points higher than the prime rate. In early summer 2025, the prime rate was 7.5%, so the interest you’d pay on money you borrow from your 401(k) likely would be somewhere in the 8.5-9.5% range. Depending on your creditworthiness, that might be a good deal. The interest on other types of personal loans were averaging 12.65% in July 2025.

If I’m OK with all of that, how much of my 401(k) am I allowed to borrow?

Half of it, in most cases. You can get up to 50% of its value in a loan, although the maximum is capped at $50,000 if you have more than $100,000 in the account.

What am I risking if I can’t repay my 401(k) loan?

For openers, you’ll be looking at a 10% early withdrawal penalty, meaning you’d immediately lose $5,000 of the $50,000 you took out on a max-amount loan. Plus, if you don’t meet the repayment terms, the IRS will add the amount of the loan to your income, meaning your tax bill becomes much more burdensome for the year in which you default.

401(k) Withdrawal Rules

The general rules governing a 401(k) allow you to make penalty-free withdrawals from retirement accounts only after reaching the age of 59 ½. Beyond that, an IRS rule mandates required minimum distributions (RMD) that begin after the age of 73.

If you take money out of your 401(k) early, the IRS requires a minimum withholding of 20%. In addition, it levies a 10% early withdrawal penalty.

If that seems prohibitive, it’s because it is prohibitive.

However, an individual might be able to withdraw funds from a 401(k) account early without penalty in certain situations, such as:

• You leave your job in the year you turn 55 or after. (It’s 50 for certain federal job designations.)
• You become disabled.
• A divorce ruling mandates splitting a 401(k).
• The birth of a child or the adoption of a child.
• The money paid an IRS levy.
• You are a military reservist called to active duty.
• You over-contributed to a 401(k) account.
• You were the victim of a disaster for which the IRS granted relief.
• You rolled the account over to another retirement plan.

Unexpected circumstances may leave you with few good financial alternatives.

It’s always a good idea to check with a financial planner and the 401(k) plan provider to understand available options, including hardship distributions.

Just know that while you might have an early withdrawal penalty waived under certain circumstances, the money you take out is subject to taxation.

Hardship Distributions from 401(k) Plan

If you are younger than 59 ½, you need to demonstrate that you have an approved financial hardship to get money from your 401(k) account without penalty. And that’s only if your employer’s retirement plan allows it; some plans aren’t required to offer hardship distributions. The first step, then, is to ask your employer’s human resources department if this is even possible.

If it is, the employer can choose which of the following IRS approved categories it allows for hardship distribution:

• Certain medical expenses
• Costs relating to the purchase of a principal residence
• Tuition and related education expenses
• Payments necessary to prevent eviction from or foreclosure on a principal residence
• Funeral expenses
• Certain expenses for repairs to a principal residence

Assuming you meet one of those criteria, you can use some of your 401(k) savings to cover the hardship’s cost and not have to pay it back as you would if you took out a 401(k) loan.

Two other points to remember about hardship withdrawals:

• The IRS limits the amount of a hardship withdrawal strictly to what you need to pay for it.
• You will owe income tax on the amount you withdraw, even if it’s for a hardship, and you might not be able to avoid paying a premature distribution penalty as well, depending on the circumstances.

Disadvantages of Closing Your 401(k)

Turning 59 ½ is the magic age for getting unfettered access to your 401(k) savings, but there are a couple of other moves you can make with that money before then. Only one, though, can be done without cost: The IRS allows individuals to cash out their 401(k) and roll it over to an IRA without penalty and without the cashed-out amount being subject to taxation.

The other comes with a price. You can close out a 401(k) without penalty when you leave your job if you are at least 55 years old, but taxes will apply to the amount you withdraw. Experts caution you to consider the consequences before taking this step.

“If you are in the 22% tax bracket and are charged that additional 10% penalty, which would be an automatic 32% cut on your money just for federal taxes,” Kendall Meade, a certified financial planner with SoFi in Charleston, South Carolina, said. “Then you would also potentially owe state taxes.”

Beyond that, closing a 401(k) has a number of disadvantages:

• The IRS levies a 10% penalty.
• The money you withdraw is treated as taxable income, potentially at a higher tax rate.
• The investment potential of pre-tax deductions, employer matches and compound interest are lost when you close out a 401(k).
• Money removed from a 401(k) account is no longer protected from creditors in case of bankruptcy.

Cashing Out Your 401(k) while Still Employed

You can withdraw money from some 401(k) plans while you’re still working for the employer who sponsors it, but in most cases, you can’t close an employer-sponsored 401(k) while you’re still working there. You could elect to suspend payroll deductions, but would lose the pre-tax benefits and any employer matches.

Note: You are permitted to completely cash out a 401(k) from a previous employer.

In some cases, if your current employer allows it, you can make an in-service withdrawal when you’ve reached the age of 59 ½.

Such funds can be used to cover a qualifying hardship. But you might also request an in-service withdrawal if your 401(k) plan offers few investment options, or you’re not satisfied with the options. You might consider expanding your options by rolling your 401(k) into an IRA.

All that said, some employer-sponsored retirement savings plans allow you to take cash out of them while you’re still on the job, though not without a cost. The tax ramifications for early withdrawals before retirement differ depending on what type of account you’re using.

Here’s what happens with a traditional 401(k):

• The IRS immediately takes 20% of the amount you’re cashing out, for tax fees.
• The IRS also levies an additional 10% tax penalty for the early withdrawal.

An early withdrawal from a Roth 401(k) is subject to penalty tax and income tax on what the account has earned from its already-taxed contributions. Plus, the IRS charges a 10% penalty fee on those contributions.

As we mentioned earlier, you can roll your 401(k) over to an IRA without paying additional tax or the early withdrawal penalty. But you only have 60 days from the time your 401(k) plan cuts the check for you to get it transferred into an IRA. Otherwise, an early distribution fee and tax penalties kick in.

Steps to Cash Out (If You Decide to Proceed)

The first step in the withdrawal process is to contact your human resources department and find out if the company’s 401(k) plan even allows for early withdrawals. Some don’t. Some do. Depends on the company, so start with a phone call to HR and ask if this option is available.

If your company’s plan does allow early withdrawals, you will need to contact the HR department or go online and request the amount needed. There will be paperwork for you to fill out that probably includes answering the question: Why do you need early access to this money?

The IRS allows withdrawals without a penalty for “immediate and heavy financial need” which is subject to interpretation. It’s best to consult with the IRS or research “immediate and heavy financial need” on their website to see if you qualify.

Make sure you take into account any penalties you will suffer – most prominently, the 10% tax for early withdrawal – before deciding on how much to take. Once the paperwork is approved, you should receive a check — minus the tax penalties, of course.

Alternatives to Cashing Out

If you don’t have an emergency fund to tap when a financial crisis hits home, there are still better ways to get money than withdrawing from a 401(k) plan.

Those choices include:

• Personal loan: This is a low-risk alternative because there is usually no need to put up collateral for the loan and interest rates are affordable if you have good credit.
• Home equity loan: This offers the lowest interest rate because you’re using your home as collateral. But it’s risky because you could lose the home if you’re not able to make payments.
• 0% balance transfer credit card: This could be a good choice, depending on how much you need to borrow and how committed you are to paying it back. You may be restricted to a small amount, depending on your credit score. If you qualify, you will have an introductory period (usually 12-21 months) to repay the loan before a high interest rate is slapped on your balance.
• IRA rollover: You can transfer your traditional 401(k) funds to a traditional IRA without paying a tax penalty. (Moving money from a traditional 401(k) into a Roth IRA will cost you, though.) A traditional IRA comes with a different set of withdrawal rules, and it might give you better investment options.
• Cash-value life insurance loan: You might be able to borrow money from your life insurance without being taxed or possibly even needing to pay it back. You’ll want to make sure, though, to leave enough cash in the policy to keep it functioning.

Debt Relief Without Closing My 401(k)

Before borrowing money from your retirement account, consider other options like nonprofit credit counseling or a home equity loan. You may be able to access a nonprofit debt management plan where your payments are consolidated, without having to take out a new loan.

A credit counselor can review your income and expenses and see if you qualify for debt consolidation without taking out a new loan.

As they say, life comes at you fast. But help can be just a phone call away.

If you’re facing financial challenges, reaching out to a credit counseling service can be a smart first step toward regaining control and finding a path forward.