Lost Your Job? What to Do With Your 401k

Losing a job brings financial concerns, especially regarding retirement savings. A 401k requires careful consideration when employment changes. Understanding your options is important to protect these funds and ensure future financial security.

Your Core 401k Options

When you separate from an employer, you generally have several pathways for your 401k assets. One option is to leave funds within your former employer’s plan. This allows continued tax-deferred growth, but you can no longer contribute, and plan rules may vary regarding future distributions.

Another common approach is to roll over the funds into an Individual Retirement Arrangement (IRA), either a Traditional or Roth IRA. This offers a wider array of investment choices, potentially lower fees, and greater control over your retirement savings. Rolling over to an IRA can simplify management if you have multiple old 401k accounts.

If you transition to a new employer that offers a 401k plan, you might be able to roll over your funds into their plan. This consolidates your retirement savings into a single account, simplifying management and potentially allowing continued pre-tax contributions. However, you should compare the fees, investment options, and features of the new plan against your old one or an IRA.

The final option is to cash out the funds. This provides immediate access to the money, but it comes with significant financial implications. The withdrawn amount is subject to immediate taxation and potential penalties, reducing your overall retirement savings.

Steps for a 401k Rollover

Rolling over a 401k involves specific procedures to ensure the funds remain tax-advantaged. There are two primary methods: a direct rollover and an indirect rollover. A direct rollover, where funds are transferred directly from your old plan administrator to the new retirement account custodian, is preferred as it avoids immediate tax withholding and potential penalties.

For a direct rollover, gather information from your former 401k plan administrator. This includes plan rules, distribution forms, contact details, and your old plan’s account number. Determine the eligible retirement account that will receive the funds, such as a Traditional IRA, Roth IRA (with tax considerations), or your new employer’s 401k plan.

To initiate the process, obtain rollover forms from your old plan administrator. Complete these forms accurately, providing all required details for a smooth transfer. Once completed, submit these forms and any other requested documentation to the old plan administrator.

Executing the rollover procedure for a direct rollover typically involves the old plan administrator sending the funds directly to the new custodian. The check, if issued, is made payable to the new financial institution with instructions for your account. This method ensures the funds never pass through your hands, thus avoiding the mandatory 20% federal tax withholding that occurs with indirect rollovers.

Conversely, an indirect rollover involves funds paid directly to you. You have a strict 60-day window from the distribution date to deposit the entire amount into another eligible retirement account. If the full amount, including the 20% withheld for taxes, is not redeposited within this timeframe, the unrolled amount is considered a taxable distribution and may be subject to income tax and early withdrawal penalties.

After initiating either type of rollover, you should expect confirmation statements from both the sending and receiving institutions. It is advisable to follow up to ensure the funds have been successfully transferred and properly allocated to your new account. The new custodian may also send a Form 5498 to the IRS, confirming the rollover.

Understanding 401k Withdrawals

Taking a direct withdrawal from a 401k before retirement age has financial consequences. To request a full or partial distribution, contact your former 401k plan administrator and complete their distribution forms. The process involves verifying your identity and acknowledging tax implications.

The withdrawn amount is treated as ordinary income for tax purposes. It is added to your other income and taxed at your marginal income tax rate (10% to 37% federally). Most withdrawals before age 59½ are also subject to a 10% early withdrawal penalty. State income taxes may also apply, further reducing the net amount received.

Exceptions to the 10% early withdrawal penalty exist, though income tax still applies. One common exception is the Rule of 55, allowing penalty-free withdrawals from your most recent employer’s 401k if you leave that job in or after the year you turn 55. This rule applies regardless of how employment ended.

Other penalty exceptions include withdrawals for unreimbursed medical expenses exceeding 7.5% of your adjusted gross income, payments made due to total and permanent disability, or distributions taken as a series of substantially equal periodic payments (SEPP). Additional exceptions may cover qualified higher education expenses, birth or adoption expenses (up to $5,000 per child), and distributions for certain federally declared disasters or emergency personal expenses. Despite these exceptions, taking a taxable distribution instead of rolling over funds immediately reduces your retirement savings due to taxes and lost investment growth potential.