401(k) Options for Terminated Employees

 |  General Self-Directed IRA Articles

coins. What to do with the funds in your 401(k) after separating from an employer

Millions of people have been laid off during the coronavirus pandemic, bringing the United States to its highest unemployment rate since the Great Depression

While economists expect the high unemployment rate to be short-lived, if you are among those that received a pink slip from your employer, you may be wondering what to do with your 401(k) plan.

A 401(k) is a retirement savings plan sponsored by an employer that allows you to dedicate a percentage of your pre-tax salary to the plan.

While you are employed, your access to the funds is very limited. But being laid off is a triggering event that allows you to take greater control of the funds. In this scenario, there are typically four options available to you. Let’s discuss each one.

Leave your 401(k) in the existing employer plan.

If you aren’t sure what to do, leaving the funds in your employer’s plan may be an option. Most former employers will allow terminated employees to remain invested in the plan if there is at least $5,000 in the account.

Although the funds will retain their tax-deferred status, there are a couple of changes to your account once your employment is terminated.

First, neither you nor your employer will be able to make additional contributions to your account. If your company offered a match that required vesting, you may lose any funds that hadn’t matured before the date of your termination.

Second, you also may face higher administrative fees now that you are no longer employed. Typically, your employer will cover fees associated with managing your 401(k), but when you leave their employment, they defer those costs to you.

The average cost of these administrative fees is 0.45% of the total invested assets. So if you have a 401(k) valued at $100,000, you would be paying approximately $450 in fees annually by leaving your funds in the existing plan.

If you aren’t able to leave your funds in the 401(k) plan because you are under the $5,000 threshold, or the plan specifically doesn’t allow terminated employees to maintain an account in the 401(k), you will want to consider the rest of your options.

Move the funds into another 401(k)

If you have been fortunate enough to find employment and you appreciate the ease of having all your retirement assets in one place, you may want to consider moving the funds from your former employer’s 401(k) plan into your new employer’s 401(k) plan. The process usually requires forms from both employers to transfer the funds between plans. If your former plan issues a check to you, be sure to give it to your new employer within 60 days of receiving the funds. If you fail to deposit the check within 60 days, you may be subject to taxes and penalties.

Before you start the process, ensure your current employer doesn’t have any eligibility requirements around participating in their 401(k). Some employers may require you to be in their employment a certain length of time before you are eligible to participate in the 401(k). If you cannot move the funds into another plan, you still have some options available to you.


Cashing out your 401(k) when you are terminated is typically advised against because of the taxes and penalties associated with the distribution. However, during the pandemic, funds from 401(k) plans have played an important role in providing income for families negatively impacted by unemployment. If you need cash right now, this may be an option you explore.

If you take a distribution before you reach the retirement age of 59 ½, you will owe federal income tax on the money, plus any applicable state and local taxes. On top of that, you will likely also be charged a 10% penalty fee for early withdrawal. So if you are in the 25% tax bracket, you will pay 35% in federal taxes and may still owe state taxes for the withdrawal.

However, some cases in which the penalty fee may be waived, such as a Hardship withdrawal. Not all 401(k) plans allow for Hardship withdrawals, and, more importantly, they may not allow terminated employees to utilize Hardship withdrawals at all.

An additional factor to consider is the impact of the Continued Assistance for Unemployed Workers Act of 2020 or the CARES Act. The CARES Act allowed up to $100,000 to be withdrawn from retirement accounts per individual from January 1, 2020, to December 30, 2020

The withdrawal will not be subject to a penalty tax for early withdrawal as long as the individual or spouse was diagnosed with coronavirus or had adverse financial consequences due to coronavirus.

The amounts can be repaid and treated as an eligible rollover any time during the three-year period beginning the day after the distribution was taken.

The amount will be treated as taxed over a three-year period unless the taxpayer elects to have it taxed in the distribution year. Additionally, if this distribution comes from a qualified employer plan like a 401(k), it is not subject to the normal 20% mandatory withholding rules if properly identified as a qualified disaster distribution.

If you took a distribution in 2020 and meet the requirements, you may be able to avoid the early tax penalties, even if the withdrawal was not originally reported as being due to coronavirus. Speak with your tax professional on how to report these distributions appropriately.

Unfortunately, these provisions did not extend into 2021. So if you are planning on cashing out your 401(k) plan, be prepared for the early withdrawal penalty if you are under the age of 59 ½. If cashing out your 401(k) doesn’t sound like the right thing for you, then consider your next option.

Rollover into an IRA

Similar to rolling your former employer’s 401(k) into a new employer-sponsored retirement plan, you can also move your retirement assets into an Individual Retirement Account (IRA).

This option may make sense if you are trying to avoid the high administrative fees and the limited offerings of 401(k) plans. Not only will you have more investment choices, but the rollover to a traditional IRA isn’t taxed. Your money can continue to compound on a tax-deferred basis until you make withdrawals during retirement.

Another advantage of IRAs is your ability to contribute regardless of your employment status. The annual limit for 2021 is $6,000, or $7,000 if you’re age 50 or older, and you can continue to make contributions to an IRA account no matter who your current employer is.

IRAs provide you the maximum amount of investment flexibility, meaning you can choose investment options that best suit your situation, as well as maximizing your access to the funds. You can take distributions from your IRA at any time. There is no need to show a hardship to take a distribution.

However, your distribution will be included in your taxable income and may be subject to a 10% additional tax if you’re under age 59 ½. Luckily, IRAs have several exceptions to the early-withdrawal penalty. These exceptions include; if the funds are being used for a first-time home purchase, medical expenses or health insurance premiums, or substantially equal payment arrangements. To learn more about these exceptions and see if one may apply in your situation, speak with your tax professional.

As with 401(k) rollovers, if you are issued a check from your old 401(k) provider, deposit it in your new IRA within 60 days to avoid penalties and taxes.

The loss of employment is a stressful time, but it doesn’t mean that your retirement goals are unattainable. Continue to make regular contributions where possible. When you have secured new employment, resume your normal investing. With careful planning, you can still meet your retirement goals, whether investing in a 401(k) or an IRA.

For more information on how you can discover your IRA investing alternatives contact us

You can also schedule a time for a call that is most convenient for you by clicking here.