Lost your Job or Changing Jobs? Know your 401(k) Options
If you have recently lost your job or are changing jobs due to the recent coronavirus pandemic, you may be wondering what to do with your 401(k) account. It is important to stay informed and understand all of your options in order to make the best decision.
Due to the Coronavirus Aid, Relief, and Economic Security (CARES) Act, penalty-free withdrawals of up to $100,000 will be allowed in 2020 for qualified individuals affected by COVID-19. Individuals can spread the income over three years for income tax purposes and will have up to three years to reinvest withdrawn amounts.
What am I entitled to?
If you leave your job (voluntarily or involuntarily), you'll be permitted a distribution of your vested balance. Your vested balance includes your own contributions (pre-tax, after-tax, and Roth) and any investment earnings on those amounts. It also includes employer contributions that have satisfied your plan's vesting schedule.
In some instances, you have no choice but to use the funds. If so, try to reduce the tax impact. For example, if you have nontaxable after-tax contributions in your account, you can roll over just the taxable portion of your distribution and keep the nontaxable portion for yourself.
While the money in your account may look attractive to withdraw, do not spend it unless you absolutely have to. If you take a distribution you will be taxed, at ordinary income tax rates, on the entire value of your account except for any after-tax or Roth 401(k) contributions you've made. If you are under the age of 55, an additional 10% penalty may apply to the taxable portion of your payout. (Special rules may apply if you receive a lump-sum distribution and you were born before 1936, or if the lump-sum includes employer stock.)
If your vested balance is more than $5,000, you can leave your money in your employer's plan at least until you reach the plan's normal retirement age (Usually age 65). Your employer must also allow you to make a direct rollover to an IRA or to another employer's 401(k) plan. As the name suggests, in a direct rollover the money passes directly from your 401(k) plan account to the IRA or other plan. This is preferable to a "60-day rollover," where you get the check and then roll the money over yourself, because your employer must withhold 20% of the taxable portion of a 60-day rollover. You can still roll over the entire amount of your distribution, but you'll need to come up with the 20% that's been withheld until you recapture that amount when you file your income tax return.
Should I roll over to my new employer's 401(k) plan or to an IRA?
Assuming both options are on the table, there is no right or wrong answer. You need to weigh all of the factors and make a decision based on your own needs and priorities. It's best to have a professional assist you with this, since the decision you make may have significant consequences — both now and in the future.