401(k): Getting to cash without the penalty

By Scot Herrick | Personal Finance

Oct 14

Seriously, this post is way too late for most people. But, perhaps in the future people will find this post and save some money.

Here it is: too many people believe if they sell the stocks in their 401(k) they will incur the 10% tax penalty for doing so. This is totally false. You only incur the penalty if you are under 59 ½ and you withdraw cash from your 401(k). And yes, there are some hardship situations where you don’t get the penalty. But this is for people who simply want out of the stock market where 40% of its value has dropped in a month and get to cash.

How do you sell your stocks in a 401(k)? You go to your 401(k) site and change the distribution from whatever mutual fund(s) to be changed to the money market fund. You change the allocation to zero in the mutual fund and move 100% to the money market fund. They get sold at the end of the day and the next day your money is in the money market fund. It sits as cash in your 401(k) until you are ready to invest again. It is not withdrawn from your 401(k) and incurring a tax penalty, just parked as cash in your 401(k).

In addition, you are taking money out of your paycheck to fund your 401(k). You still want to put money into your 401(k) because you still get the tax advantages and you want as much money in there as possible to take advantage of the upturn in the market after this disaster. But you also need to change where your paycheck puts your funds in the 401(k).

Right now, they are undoubtedly also going into the very mutual funds that you don’t want them in. So also change the investment direction to your money market investment option in your 401(k). This way your paycheck money goes into the money market fund as cash in your 401(k).

Now, I thought people knew this. But I have talked to way too many people the last couple days who are stunned they can move their money out of the mutual funds in their 401(k) to the money market option without a penalty. I was stunned they didn’t know this. Plus they didn’t know they can take their paycheck deductions and put them into the money market investment option in the 401(k) and still build their 401(k) without going into the stock market until it gets better.

I’m not implying this is something you should do (the investment police will find me), but this is something too many people appear to not know they can do.

Update: and the penalty may be removed temporarily if a particular candidate is successful:

Barack Obama plans to propose a series of temporary tax credits and suspensions of tax penalties Monday afternoon as part of his new economic plan. The Democratic nominee will propose a temporary tax credit for firms that create new jobs in the United States over the next two years, and penalty-free withdrawals from IRAs and 401Ks in 2008 and 2009.


About the Author

Scot Herrick is the author of “I’ve Landed My Dream Job–Now What???” and owner of Cube Rules, LLC. Scot has a long history of management and individual contribution in multiple Fortune 100 corporations.