Can I Withdraw My 401k if I Get Laid Off?

No matter how prepared you are, there is never a good time to face a layoff. Between the uncertainty of figuring out what comes next and the reality of making new life adjustments, one of the questions that may be on your mind is, “Can I withdraw my 401(k) if I get laid off”?

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If you have recently experienced a layoff and are worried about what that means for your 401(k), you still have plenty of options. Read on to learn more about what a layoff means for your savings and what steps to take to stay on top of your finances.

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Can You Withdraw Your 401(k) if You Get Laid Off?

The good news is that you can withdraw your 401(k) if you get laid off. Since a 401(k) is a tool for retirement savings, the money remains yours even if you no longer have a job. The caveat is that taxes and potential penalties are involved, depending on your situation.

The IRS states that withdrawing a 401(k) if you are below the age of 59½ years incurs a 10% early withdrawal tax. For example, if you plan to withdraw $15,000, your penalty is $1,500.00.

However, there are exceptions to the early withdrawal penalty, which include birth or adoption, disability, death, disaster recovery distributions, and separation from service during or after the year you turn 55. For public safety employees, that age limit goes down to 50.

Penalties may also apply under the following conditions:

• Defaulting on a loan from your 401(k)

• The unique rules of your 401(k) plan, which may incur additional penalties

• Your state of residence, since some states have different penalties on early withdrawals

• Unless it is a qualified distribution from a Roth 401(k), you may still need to pay income tax on the withdrawn amount

Options for Your 401(k) After a Layoff

You may wonder what you can do with your 401(k) after getting laid off by your employer. Although there is no “one size fits all” rule, there are a few general options that you can consider depending on your financial situation.

Your first option is to do nothing and leave your 401(k) with your former employer, which decreases the hassle of making adjustments. However, make sure that your plan lets you do that since it may not allow you to keep the funds in the plan once you leave the company.

Another option is to roll the plan into an Individual Retirement Account or IRA. There are multiple types of IRAs, like traditional IRAs with tax-deductible contributions and Roth IRAs with after-tax contributions.

A third option would be to wait until you are employed at a new workplace and then transfer your current 401(k) to a new employer’s plan.

Finally, you can simply withdraw your money from the 401(k). However, this option does come with tax and penalty charges if you don’t meet the criteria.

Tax Implications of Withdrawing Your 401(k) After a Layoff

Withdrawing your 401(K) funds after a layoff comes with state and federal tax implications since the money is considered an increase to the gross income you made for that year. The gross income increase also means you may lose benefits and tax credits.

Some states do not tax retirement income, while others do, so checking your state’s rules is essential before withdrawing. You will still need to handle the federal income taxes since the IRS considers the withdrawn funds as taxable income for the year, and your taxable rate depends on your total income, tax brackets, and filing status.

Fortunately, you can avoid some early withdrawal penalties, covered in the next segment, if you meet specific criteria.

How To Avoid 401(K) Early Withdrawal Penalties

Before withdrawing your 401(k) early, check if you meet the criteria to avoid penalties. There are numerous exceptions, such as:

• Medical bills that exceed 7.5% of your adjusted gross income

• Having a total or permanent disability

• If you are a first-time home buyer

• Distributions from a pension-linked emergency savings account

• Distributions made due to an IRS levy of the plan

• Have been laid off at or above the age of 55

• Have a terminal illness certified by a physician

Alternatives to Withdrawing Your 401(k)

Unless you need the funds in your 401(k) account, there are alternatives to withdrawing your funds. For example, if you are still employed, you can take a 401(k) loan and use those funds instead.

You can also look into ways to maintain your existing funds aside from the plan, such as exploring other savings options or financial resources before you tap into the money you are keeping aside for retirement. For example, you can get a retirement savings account from a bank or financial institution, which can help you earn interest.

How To Manage Your 401(k) During Unemployment

During your unemployment period, you can look deeper into your investment portfolio and make financial sense adjustments. Take fewer risks and adjust your investments to reflect your current financial situation.

Planning for retirement should not come to a halt when you are unemployed. Although you can temporarily stop making contributions, you can also make other adjustments like:

• Reviewing the details of your severance package and understanding how much liquidity you have in your accounts

• Remove non-essential expenses and create a new budget strategy that lets you keep some funds on the side for retirement

• Looking for a new job that offers 401(k) plans and roll over your existing plan when possible

You can also pause your contributions to your retirement funds if you are transitioning to a new job or are still on the hunt for one.

Long-Term Impact of Withdrawing Your 401(k) After a Layoff

Cashing out your money reduces your retirement savings potential. It makes it more challenging to start over since you have less time and need more money to reach your financial goal.

Unless the money from the 401(k) is your only financial net, keep that money aside or roll it over to an IRA so that you don’t lose your contribution and pay penalties that cost you more in the long run.

Another option is to leave your 401(k) untouched until you find a new job. These two strategies are the best for long-term growth and keeping your funds intact until you have a financial plan for the future.

Final Thoughts: What To Do With Your 401(k) After a Layoff

Whether you expected the layoff or it was a surprise, your retirement savings should never suffer due to life’s circumstances. Keeping your 401(k) untouched or rolling over to an IRA are the best solutions to keep your investment safe until you are back on your feet.

The matter is less about “Can I withdraw my 401(k) if I get laid off?” and more about “Should I?” when it comes to maintaining your money and the implications of penalties if there is no other option.

Since every state and situation differs, consult a financial planning professional before deciding on a course of action. The more information you have, the better prepared you are to deal with any obstacles or hurdles you may encounter when planning to withdraw funds early from your 401(k).

401(k) Withdrawal FAQ

Take a look at some of the answers to frequently asked questions about 401(k) withdrawals. See if any apply to you, especially if you’re wondering about what happens if you were to get laid off.

• Can I cash out my 401(k) if I get laid off?

  • Yes, you can cash out your 401(k) early if you get laid off. However, early withdrawal comes with penalties if you don’t meet specific criteria set by the IRS.

• What are the tax penalties for withdrawing my 401(k) early?

  • Penalties include the funds being counted as taxable income and a 10% penalty on the total amount of money withdrawn. Some states may impose additional taxes, and different 401(k) plans could have withdrawal restrictions or other fees.

• What happens to my 401(k) if I leave it with my old employer?

  • If you leave it with your employer, nothing will happen to your 401(k). However, stay on top of your 401(k) regardless, as laws change frequently or your former employer either goes out of business or becomes acquired by another company. Also, some employer 401(k) plans require a minimum balance on the account, so you may need to decide what to do with those funds if they will not allow you to keep them. You can choose to withdraw or roll them over into another account, the latter of which is going to have the most tax advantages.

• Should I roll over my 401(k) after being laid off?

  • Rolling over your 401(k) is an excellent idea after being laid off since your retirement savings stay intact, and you do not have to pay tax penalties.

• How can I access my 401(k) funds without penalties?

  • To avoid the 10% early withdrawal penalty on your 401(k), you must meet specific exceptions, such as:

    • Reaching age 59½

    • Leaving your job in or after the year you turn 55 (Rule of 55)

    • Taking substantially equal periodic payments (SEPP/72(t) rule)

    • Having a total and permanent disability

    • Covering unreimbursed medical expenses exceeding 7.5% of your adjusted gross income

    • Facing certain federally declared disasters

    • Being a victim of domestic abuse (up to $10,000, starting in 2024)

    • Having a terminal illness

  • If you’re a first-time homebuyer or have higher education exceptions, this doesn’t apply to 401(k)s. However, it is permissible with IRAs.

This article originally appeared on GOBankingRates.com: Can I Withdraw My 401k if I Get Laid Off?