Even if you are not yet 59 1/2 years old, if you get terminated you can cash out the money in your 401k plan. However, unless an exception applies, you have to pay not only the income taxes on the distribution, but also a 10 percent early distribution penalty. If you do not face a severe financial hardship that necessitates a distribution, consider rolling over the money into a traditional IRA so that you continue to allow the money to grow in a tax-sheltered account and avoid the income taxes and early withdrawal penalty. If you do cash out the 401k plan, you need to report it properly on your income taxes.
Cash out your 401k plan at your former employer by completing the required distribution forms to tell your employer where to deposit the money. After the year ends, your employer will send you a Form 1099-R documenting the amount you cashed out and the amount withheld for your anticipated federal income taxes.
Complete Form 5329 unless you are 59 1/2 years old. If you are 59 1/2 years old, you do not owe the early withdrawal penalty and can skip to Step 4. On Form 5329, calculate your 10 percent early withdrawal penalty. If an exception applies in your situation so you do not need to pay the penalty, document it on the form. Exceptions include if you were at least 55 years old when you were terminated or if you have a permanent disability.
Report the penalty from Form 5329 on line 58 of your Form 1040 income tax return. When you calculate your total tax liability, this amount will be included.
Report your 401k plan distribution on line 16b of your Form 1040 tax return. This amount adds to your taxable income for the year. The early withdrawal penalty does not replace the income taxes on the distribution.
Add the amount of money withheld from your 401k plan cash out to any other federal income tax withholding and report the total on line 61. You can find the federal income taxes withheld on box 4 of your Form 1099-R. You can find federal income tax withholding for your job on your Form W-2.
Items you will need
- IRS Form 5329
- IRS Form 1040