What to Do With Your 401(k) if You Get Laid Off

If you’ve been laid off, furloughed or let go from a job, your entire lifestyle can change overnight. Unemployment rates hovered around 6% during the early months of 2021. There were around 10 million unemployed individuals in April 2021.

When facing unemployment, it can be natural to look at money set aside for retirement. If you had a 401(k) with your former employer, you’ll need to decide what to do with the funds in the account. There are several options to consider, but each one comes with potential benefits and costs.

Here’s what you can do with a 401(k) if you are laid off:

— Leave the money in your 401(k) if you have more than $5,000.

— Move the funds into an individual retirement account or 401(k) plan at a new job.

— Withdraw the funds and face potential penalties.

Read on to learn about your 401(k) options after losing your job, along with criteria to think through before making any moves.

Look at Your 401(k) Balance

The amount in your 401(k) can impact the options available. “If your account balance is below $5,000, your employer has the option of removing you from the 401(k) plan by distributing the funds,” says David McCormick-Goodhart, a financial advisor at Savant Wealth Management in McLean, Virginia. For balances above $5,000, the employer will need to leave the funds in the 401(k) unless you ask for the amount to be removed.

If you’re not sure how much you have accumulated, check the balance of your account. For balances that are under the $5,000 threshold, you can ask your employer if the company plans to distribute the funds, or if another policy is in place.

[Read: How Much Should You Contribute to a 401(k)?]

Consider Leaving the Money in Your 401(k) Account

If your account balance is above $5,000, you may decide to keep the 401(k) plan with your former employer. You won’t be able to keep contributing to the plan, but the invested money could grow over time.

Leaving the 401(k) funds at the company where you used to work could lead to some drawbacks. “You are limited to the investment options that are available in the 401(k) plan,” McCormick-Goodhart says.

You could also face the uncomfortable situation of having to communicate with a former employer to ask for an address or beneficiary change. “You may need to go through the employer’s human resources department to obtain the necessary paperwork, which can be both inconvenient and awkward after a job loss,” McCormick-Goodhart says.

Move the Funds to an IRA or Another 401(k) Plan

If you have another job in place, you can ask your new employer if a 401(k) plan is available. “It is typically permissible to move your old 401(k) into a new employer’s 401(k) when you get another job,” says Jason Field, a financial advisor at Van Leeuwen & Company in Princeton, New Jersey.

You could also choose to roll over the 401(k) into an IRA. “There is no tax due for making this rollover, if no money is directly withdrawn to the employee,” Field says. “Creating an IRA will give you a very wide range of investment options, but would require someone to manage them.”

If you file for bankruptcy, the implications for funds in a 401(k) will not be the same as the consequences for an IRA. “Your 401(k) cannot be included in a bankruptcy proceeding,” says Landon Loveall, a certified financial planner at KB Financial Advisors in San Francisco. Creditors will not be able to access the account. “An IRA, on the other hand, doesn’t have those protections,” Loveall says.

[Read: 401(k) Mistakes Job Hoppers Make.]

Withdraw From the 401(k) Account

If you need funds to help cover costs like a mortgage payment and groceries, you might be considering taking money from a 401(k) account. “While it may be tempting to cash out your 401(k) after leaving your job, proceed with caution before doing so,” McCormick-Goodhart says. “These accounts are meant to be a vehicle for long-term retirement savings, so cashing out after a job loss can jeopardize your financial plan in the long run.”

Using 401(k) funds now to pay for immediate expenses could mean that later, when facing retirement, you don’t have that same amount available. The funds in the account also won’t be given a chance to grow during the next decades to build up a nest egg for retirement.

Taking money from a 401(k) typically leads to penalties and taxes. If you are not yet 55 years old, you will usually face a 10% penalty on the amount taken out of a 401(k) after leaving your job. The withdrawal would also be considered taxable income for that year.

The CARES Act and a later stimulus bill provided temporary adjustments to 401(k) withdrawals. If you met certain criteria, you may have been able to withdraw up to $100,000 without facing penalty. You can then spread out the tax impact of the withdrawal over the next three years. If you pay back the money within three years, you can avoid having the distribution marked as taxable income. It is not required that companies follow these provisions, so you’ll need to check with your employer to learn how a withdrawal during the pandemic could impact your finances and taxable income.

[Read: A Guide to 401(k) Vesting.]

What Happens to My 401(k) if I Get Fired?

The same options apply to your 401(k) regardless of being laid off or fired. “One thing to keep in mind is the vested value of any employer match that has been made by the company,” Field says. “Most plans require an employee to work for a certain amount of years before the company match is considered the employee’s money.”

As you search for a new job, it may be suitable to temporarily leave the funds in the 401(k). Once you get a new job, “you will most likely have the option of rolling that 401(k) over to the new employer’s 401(k),” says Michael Morgan, president of TBS Retirement Planning in Hurst, Texas. “Your other option would be to roll your 401(k) into an IRA of your choice.”

More from U.S. News

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How to Pay Less Tax on Retirement Account Withdrawals

What to Do With Your 401(k) if You Get Laid Off originally appeared on usnews.com

Update 01/27/22: This story was published at an earlier date and has been updated with new information.

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