Can I Cancel My 401(k) and Cash Out While Still Employed?

If you’ve been contributing to a workplace 401(k) for years, chances are you intend to use that money for retirement. But if the unexpected happens, and you need or want those funds earlier, you may wonder, “Can I cancel my 401(k) and cash out while employed?”

You typically can’t cancel a 401(k) or close your workplace retirement account entirely. But you can withdraw funds from your 401(k). You can also drop your payroll deductions down to zero so you’re no longer contributing to it. Here’s a closer look at your options if you need to tap into your retirement savings, along with potential alternatives to consider.

Can I cancel my 401(k) if I still work for my employer?

No, you typically cannot cancel or fully cash out your 401(k) while you are still employed by the company that sponsors the plan. Most 401(k) plans don’t allow full account distributions unless you leave your job, retire, or qualify for specific withdrawal options like hardship or in-service withdrawals. Even then, these withdrawals usually provide only partial access and come with penalties and taxes if you’re under age 59½.

If you no longer want to contribute to your 401(k), you can stop payroll deductions, effectively pausing future contributions. However, your account balance will remain invested until you leave the company or reach retirement age. In the next section, we’ll explore your options for accessing funds from your 401(k) if you need them.

401(k) withdrawal options

If you’re thinking about a 401(k) withdrawal, here’s a look at your choices, how they work, who they’re available to, and the pros and cons of each. 

In-service withdrawal

Some 401(k) plans permit in-service withdrawals, which involve taking money out of your 401(k) without providing proof of financial hardship. That said, there may be strict rules about who can qualify for these withdrawals. For instance, you may need to be with your company for five years. 

People often opt for an in-service withdrawal if they want to invest their money elsewhere. If your 401(k) has limited investment options, for example, you may decide to transfer that money to an IRA for more choices. An in-service withdrawal may also be an option if you have a large, unexpected cost to cover. 

Hardship withdrawal

Hardship withdrawals are another option if you’re facing unexpected financial difficulties. Let’s say your spouse loses their job and you’re struggling to make ends meet; in this case, it may be worth considering a 401(k) hardship withdrawal. 

These withdrawals, also called safe harbor distributions, are permitted for people who have a serious, immediate financial need. These types of expenses could constitute an immediate financial need, per the IRS:

• ​​Medical bills for the employee, the employee’s spouse, dependents or beneficiary.
• Expenses related to the purchase of an employee’s home.
• One year of college costs for the employee or the employee’s spouse, children, dependents, or beneficiary.
• Imminent eviction or foreclosure.
• Funeral costs for the employee, the employee’s spouse, children, dependents, or beneficiary.
• Expenses related to qualifying damage to the employee’s home.

401(k) loan

A 401(k) loan could be another option. Instead of simply withdrawing money from your retirement savings, you borrow it. Generally, employers restrict how much you can withdraw using a 401(k) loan. For instance, you may only be able to borrow half of your vested account balance. Check with your employer about rules and restrictions if you’re considering a 401(k) loan. 

Despite potential limitations, borrowing against your 401(k) could be a better option for preserving your retirement nest egg than an outright withdrawal. With a loan, you’ll be paying that money back over five years, which could put you in a better financial position once you reach retirement age. 

What to consider before you withdraw from your 401(k) 

You should think long and hard before withdrawing money from your 401(k), as doing so comes with some risks. Here are some of the most important things to consider. 

Tax implications

You’ll generally pay ordinary income taxes and a 10% penalty if you make an in-service or hardship withdrawal from your 401(k) before age 59 ½. 

You won’t be charged a 10% penalty if you make an early withdrawal for a reason that aligns with certain IRS exemptions, though. Some exemptions include withdrawals made for birth or adoption or those made due to the death or permanent disability of the employee. 

You won’t be taxed on a 401(k) loan, so it could be a better alternative if you can repay what you’ve borrowed.   

Impact on retirement savings

The more money you have in your retirement savings, the easier it is to grow your nest egg when the market swings in your favor. If you take money out of your 401(k), either through a withdrawal or loan, it limits your potential gains. Here’s a quick example:

Let’s say you have a 401(k) balance of $50,000. Assuming you leave that money invested and earn around 7% per year, you’d have over $70,000 invested after five years with no additional contributions. 

Now let’s say you withdraw $30,000 from your 401(k), leaving you with a $20,000 balance. In five years, you’d have just over $28,000 in your 401(k), assuming 7% annual earnings and no additional contributions. A big withdrawal could make it a lot more difficult—or even impossible—to catch up on your savings before retirement. 

Loan repayment risks

If you plan to leave your job quickly, a 401(k) loan could present a major risk. That’s because you may need to repay your loan in full before parting ways with your current employer. If you’re not able to do so and you’re under age 59 ½, you’ll generally need to pay taxes and the 10% IRS penalty on your outstanding loan balance. 

Depending on how much you’ve borrowed, taxes and penalties could be a major financial hit, especially if you’re not on sound financial footing to begin with. So a 401(k) loan is generally only a good choice if you plan to stay with your current employer for several more years. 

Most 401(k) loans come with five-year repayment terms, though it’s possible to repay your balance early if you don’t plan to stay with your company too much longer. 

My preferred option for accessing funds for unexpected emergencies is to actually have an emergency savings fund. I typically recommend saving 12 to 18 months of expenses in a safe, liquid option, such as a high-yield savings account.

If you already have a HELOC and can afford the extra payments, that is not a bad option. However, given today’s interest rates, it may be harder to start if you don’t.
Borrowing against your 401(k) is OK if you’re serious about paying yourself back, you’re not thinking of changing your job, and you have a low risk of losing your job. In fact, a recent study shows that borrowing against your 401(k) does not negatively impact your long-term retirement savings.

Catherine Valega, CFP®

Alternatives to a 401(k) withdrawal

Before withdrawing from your retirement account, evaluate whether one of these options makes more sense. 

Home equity line of credit (HELOC)

A HELOC allows you to borrow against your home’s equity through a revolving line of credit, similar to a credit card. It offers flexibility to withdraw funds as needed, often at lower interest rates than unsecured loans. 

However, HELOCs typically come with variable interest rates, meaning your payments could fluctuate over time. While they provide accessible funds, it’s essential to remember that your home serves as collateral, adding risk if you’re unable to repay.

Home equity loan

A home equity loan provides a lump sum based on your home’s equity, with fixed monthly payments and interest rates. Unlike a HELOC, a home equity loan has a predictable repayment structure, making it easier to budget for. It’s a popular choice for those needing a substantial, one-time amount, such as for home renovations or debt consolidation. 

However, like a HELOC, a home equity loan is secured by your property, so failure to repay can put your home at risk.

Home equity agreement

A home equity agreement provides access to funds without monthly payments or interest. Instead, you get a lump sum in exchange for a share of your home’s future appreciation. 

This option can be attractive if you want immediate cash without adding to your monthly obligations, but it requires sacrificing some future equity gains. It’s ideal for those with significant home equity who are comfortable with sharing future appreciation in exchange for cash today.

Home sale-leaseback

With a home sale-leaseback, you sell your home to a buyer and lease it back, giving you access to equity while remaining in the home. This option allows homeowners to unlock cash without taking on new debt or monthly payments. However, it’s a more complex transaction that typically involves fees and may limit your future ownership rights. It’s often best for those who need substantial liquidity and are open to alternative ownership arrangements.

Personal loan

A personal loan offers a straightforward borrowing option with fixed terms and interest rates, typically without requiring collateral. Unlike home-based financing, personal loans rely on your creditworthiness and can be used for various expenses, including debt consolidation or emergency costs. 

While they provide a quick solution, interest rates on personal loans are generally higher than secured options, and approval depends on credit history. Personal loans are best suited for those who need a fixed sum and have a strong credit profile.

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