Disadvantages of cashing out your 401(k)
There are two major disadvantages to cashing out your 401(k): taxes and lost earnings.
Unless you're rolling the money into a new 401(k) within 60 days or are eligible to withdraw money without penalties, taxes are likely to be the biggest disadvantage.
For example, if you cash out a $100,000 account, you stand to lose $10,000 to the government for the early withdrawal penalty, plus income taxes ranging from 10% to 37%, depending on your tax bracket. Your $100,000 safety cushion could turn out to be worth less than $60,000 and the IRS will get a huge cut.
You'll also lose out on compound earnings. One advantage of 401(k) accounts is that your investments typically make money over time, which adds value to your account.
As your savings increase over time, your earnings are reinvested and earn money. The gains from long-term 401(k) plans can often become a significant part of the total account. You'll lose this benefit if you cash out the money.
Alternatives to cashing out your 401(k)
If you leave your job, your best option will be to transfer your 401(k) from your former employer to your new one or to an IRA.
Using the cash to cover daily expenses should be a last resort, and most financial advisors strongly recommend against it.
If you are considering cashing out your 401(k) because you need money, you should explore other alternatives first, including tapping home equity or taking out tax-free Roth IRA contributions
Should you cash out your 401(k) if you quit or are fired?
Unless you meet one of the criteria for making an early withdrawal from your 401(k) or you want to move your money to a 401(k) sponsored by a new employer, it's almost never a good idea to cash out your account.
If you cash out your 401(k) after getting fired, you've not only lost a job and benefits such as an employer match, but you're also losing money in the form of early withdrawal penalties, taxes, and future compound interest.
