Depending on how long you’ve worked and how generous your employer has been with their matching program, you may have accumulated a nice balance in your 401(k) retirement plan. For folks with an entrepreneurial streak, that nest egg can look mighty tempting when opportunities arise. If you’re thinking about starting a new business and funding it with your 401(k), stop and think twice.

Here are some things to consider before you withdraw the money, and they are definitely worth thinking about, assuming that you have decided not to roll your 401K over into a different plan and you don’t qualify for any IRS Special (Hardship) Case:

  1. Making an early withdrawal will increase your taxable income, and you will need to make sure that (if possible) that Federal and state withholding is taken.
  2. You will need to pay an early withdrawal penalty at tax time of 10% of the total.  If you aren’t generating income, it is unlikely that you will have that sum on April 15th.  It is probably a good idea that you put that amount aside.
  3. You will no longer have an asset accumulating for your retirement years.  What will you do to either replace or restart a fund like this.   Depending on how old you are, this may be difficult to impossible to do.
  4. You will no longer have a true emergency fund.  If what you are experiencing strikes you as an emergency, then there is no decision to make.  But if it is something that you can truly remedy, consider another alternative.

Those four points are normally enough to discourage most.  However, if you are still interested in making this withdrawal, there are necessary, slightly more pleasant things to consider:

  1. Consumer debt repayment should be a top priority.  There is no reason to carry balances, make monthly debt payments and lose the benefits of your retirement savings.  At the very least, you will need to relieve the stress on your monthly income by repaying your debt.
  2. Live on less.  Whether you choose to start a business, go back to school or take a lower paying job, you will need to discipline yourself until your income is at a level where you want it to be.  That means learning to live without little extravagances that you may be used to living on when your salary was continually coming it.
  3. Live on a strict budget.  This probably sounds like strange advice when you are looking to take a large lump sum into your bank account.  That is exactly why you need to have a budget that takes into account what your true expenses are. If you live according to what is in your bank account, you are likely to spend it faster and with less discipline.

Cashing out your 401K is a big decision; however, by the time a person is truly considering whether or not to take this action they are decided.  If that is your position, it will benefit you to take a look at this list on a regular basis, and remember to start working quickly to rebuild as soon as you can.

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Simon Zhen

Simon is a research analyst for MyBankTracker. He is an expert on consumer banking products, bank innovations and financial technology.
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