How Does Cashing Out Your 401(k) Affect Unemployment Benefits?

Cashing out your 401(k) may make you ineligible for unemployment benefits completely, but the details vary from state to state, claims Vitaver Staffing. Withdrawing a 401(k) while unemployed has other disadvantages, too, including income taxes and a 10 percent penalty for those under 55.

A 10 percent penalty applies to all 401(k) withdrawals made if the owner is under age 59 ½ (age 55 if he is unemployed, and age 50 for some public safety workers), unless specific circumstances apply, according to Vitaver Staffing. The penalty does not apply if the amount is used to pay medical bills that are larger than 7.5 percent of the individual’s adjusted gross income, but any amount exceeding what is sufficient to pay the bills will be taxed. The penalty also does not apply if the IRS levies the account or if the amount is spread over the individual’s remaining life expectancy.

Rolling over the 401(k) into a traditional or Roth IRA may provide significant tax advantages, notes Vitaver Staffing. IRAs allow penalty-exempt withdrawals to avoid foreclosure and eviction, to pay for qualified higher education expenses and, up to a certain amount, to pay for purchasing a first home. An unemployed individual is likely to be in a much lower tax bracket that year, and since rolling over a 401(k) into a Roth IRA is subject to tax, a rollover may be particularly attractive that year.