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 It is not withdrawn from your 401(k) and incurring a tax penalty, just parked as cash in your 401(k).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.

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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.

  • Arnie says:

    There is another way to protect some of your money in a 401K – loan yourself the money. Within my plan, I have the ability to take our two loans per calendar year — these loans are automatically paid back through a payroll deduction. My interest rate has been between 6% and 7% for loans I have taken. During the past year, I have protected some of my money by loaning it to myself. I also figure, it’s better to borrow from me, than from some bank [or credit card company].

    Within my plan, you can borrow up to 1/2 or $50K — which ever is smaller. I usually set it up to be paid back quickly [6 to 12 months].

    Basically I like this situation — because I like my banker and my customer isn’t too bad either.

    • Scot says:

      @Arnie – While this looks like a good idea, you need to be very secure in your position to do this. If I am not mistaken, if you take out a loan from your 401(k) and have payroll deductions taken to repay it, if you are laid off, the entire balance is due.

      Any financial guru’s out there that can confirm this?

  • Arnie says:

    Your right about the payback — you either have to pay it back [I believe within 90 days – could be more, could be less] –OR– it is considered a distribution, and governed by whatever distribution rules and regs you are under.

    And as far as I can, there is no security – as the Wizard said “No Way, No How!”

    • Scot says:

      @Arnie – Thanks for posting this, Arnie. Loans carry a risk if you are laid off and you have one. Poor form to have to use all your severance pay just to pay off your 401(k) or be faced with a distribution!

  • Nick says:

    I was recently laid off, I have heard that people laid off currently do not incurr tax penalies when whithdrawling from 401k’s. Is this correct?

    • Scot says:

      @Nick – There are legal reasons why I can’t recommend one way or the other on this, Nick. However, I have not heard of this option being available. It was being kicked around, but I do not know if passed or not.

  • […] of managing your career is managing your 401(k). Right now, your 401(k) is looking ugly. Should you stop contributing to your […]

  • Chris says:

    Some of the mentioned statements are “Not” “TOTALLY ACCURATE” and with the serious recession and a very poor enocomy. Do you folks really want to gamble your hard working dollars, with todays Stock Market. We are heading into a deep depression, not seen since the 1930″s. Or you have to do is read the Newspapers, or watch T.V. to see the negative results of where your investments are going. Anyway good luck…….

    In my ” case I 55 Years of age, at present I have a personal loan out for $ 2,500 Dollars from my company 401K Program.

    I plan on resigning before 2010, because I FIRMLY BELIEVE that things are going to get real bad…

    I plan to RESIGN and find a job with the same amount of pay, but much closer to my home. The main reason for this is “Gas” prices will be going way up….Less travel on road, I won’t have pay so much at the pumps.

    I plan on totally cashing out my 401k, the company keeps 20% for federal Government and I get 80%.in cash for me ..because I am 55, I will “not” have pay the 10% tax penalty. I lived in a State where there is “No” state income tax, Thank God…because for every Dollar you make, you must pay one Dollar back to uncle sam, thats if your are one of those folks that live in a State where you pay federal & State Taxes……not me…I love my money, I WORK TOO HARD TO EARN IT. I am not giving the IRS U.S GOVERNMENT MY MONEY TO FIGHT TWO MORE “VIETNAMS” ALL OVER AGAIN….BUT THATS ANOTHER STORY…..Bottom line–If you want any of your money, get it before 2010, because folks your going to lose it.

    Oh YES DON’T BE FOOLED BY THE “FDIC” WITH YOUR MONEY IN THESE BANKS. SURE THEY INSURE YOUR MONEY, BUT THEY DON’T TELL EVERYTHING….IF THE BANKS “FAIL” AND CLOSE THEIR DOORS, THEY BE ALLOWED TO PAY YOUR MONEY BACK, BUT UP TO A YEAR AND IN SMALL AMOUNTS IN MOST CASES.

    Well Good Luck…folks I hope I was able to provide some help to some of you…

    • Scot says:

      Well, I never thought bat-shit crazy wingnuts would visit this site but there you go.

      This comment is based on some other planet Chris is living on. If you want to look at the reality here on planet Earth, follow the advice.

      The whole idea of “not gambling your dollars” is to get your 401(k) to cash as I described it here. You can do whatever you want with your investments, but cashing out your 401(k) and incurring the 10% penalty is pretty dumb personal finance.

      Sigh.

  • 401kpenalty says:

    It is quite hard to work with 401 (k) with stock selling and I have to say that you are right, this is new information for me and I have just realised it. Also the restrictions may cause some problems for a lot of people.

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