If you're leaving your job because you've been laid off or you've found work elsewhere, you might be wondering what happens to your 401(k) plan. (See our overview of 401(k) plans for more information about this type of employer-sponsored retirement plan.)
You might want to tap into your retirement account to pay monthly bills while you look for a new job or wait for your first paycheck. Or, you might not need to touch those funds, but you might have questions about what to do with your account going forward.
The money you have paid into your 401(k) always belongs to you. However, you'll usually have to pay income tax on the amount you withdraw from the account. You might also owe penalties if you take out the money too early or if you don't follow the legal rules for transferring your money.
When you leave a job—whether involuntarily (if you're laid off or fired) or voluntarily (if you quit)—your options for dealing with your 401(k) depend, in part, on how much money is in the account. If your account has $1,000 or less, your employer will cash it out and write you a check for the balance. You'll receive the balance of the account, minus income tax withholding and an early withdrawal penalty of 10%, if you are not yet 55 years old.
If your account includes an employer match, you'll need to figure out if you are vested in that money. In some 401(k) plans, employees are immediately vested in the money their employer contributes to their account. However, most plans have a vesting schedule by which employees are entitled to the money the employer deposits only over time. For example, you might be entitled to half of your employer's payments each year, until you're fully vested after three years. In general, you'll continue vesting only if you're still employed.
The amount you've paid into your 401(k) belongs to you, and you always have the option to simply withdraw the money. However, this option doesn't come cheap. Because this money was not taxed when it was withheld from your paycheck, you'll have to pay income tax on whatever you withdraw. (Some employers offer Roth 401(k) plans, which are similar to traditional 401(k)s except that the contributions are taxed up-front. As a result, you can withdraw tax-free the amount of your Roth 401(k) contributions.)
You might also have to pay a 10% early withdrawal penalty, unless you are at least 55 years old. (Once you turn 55, you don't have to pay a penalty on any amount you withdraw after leaving your job for any reason.)
Another option is to leave your 401(k) in your former employer's plan. This option might make sense if you like the plan's investment options and the fees are low, for example. However, you won't be able to make any more deposits into your account.
If you have less than $5,000 in your account, your former employer has the option of forcing you out of their retirement plan by transferring your funds into a "safe harbor" IRA (individual retirement account). As noted above, employers generally cash out accounts with less than $1,000 in assets.
Another option is to roll your 401(k) funds over into an IRA. To avoid tax withholding and penalties, you should have the rollover done directly, without taking possession of the money yourself. Ask your former employer to write a check directly to your new IRA trustee for the full amount.
If you are already 55 years old, think carefully about whether you'll need to withdraw money from your account before choosing this option. Although you can withdraw money from a 401(k) without paying a penalty once you are at least 55, you must reach the age of 59-and-a-half before you can make penalty-free withdrawals from an IRA.
If you get a new job in short order and you have at least $1,000 in your former employer's 401(k), you can transfer your money to your new employer's 401(k) plan. That way, you can keep the tax benefits of having a 401(k) and begin contributing to your plan again. You can also take advantage of any match your new employer offers. Your new employer can help you with the paperwork required to move your retirement account.
