How to Cash Out a 401k When Terminated

Do you get to keep your current 401(k) if you quit?

Generally speaking, you can keep your money in your 401(k) when you leave your job -- with some important caveats.

First, while you can keep your money in your account, you won't be able to continue making contributions or receive any additional employer-matched 401(k) contributions.

The second major caveat involves vesting. With some company match programs, you must work for a certain minimum time before you own any matching funds your employer provided. You always own the money you personally contributed.

Employer matching contributions are a key part of the success of 401(k) plans. If you contribute a set percentage of your paycheck to a 401(k), your employer might match the contribution up to a certain limit, such as 3% or 5% of your salary.

Unfortunately, if your employer sets a vesting period, such as one year, and you quit or lose your job before then, you lose the matching funds. This can be a big blow to your retirement savings efforts.

Cashing out your 401(k) after quitting your job

If you've quit your job, you may be tempted to cash out your 401(k). However, you should not just withdraw the funds. You will take a huge tax hit and jeopardize your retirement security if you do.

If you quit and you are going to a new employer, you may be able to move the money to your new company's 401(k) plan. If you aren't going to a new company or your new employer doesn't offer a 401(k), you can move the money into an IRA.

If you are going to a new employer, here's what you should do to make sure you can transfer your retirement plan assets:

• Check your eligibility. Some employer-sponsored plans require you to work for a certain period of time before you're eligible to participate in their 401(k). If you want to roll over your current account to a new 401(k) plan, you need to make sure you're eligible for the plan first.
• Transferring funds. You'll need to make sure your new employer accepts 401(k) rollovers before you transfer your funds from your former employer's 401(k) to the new account. Sometimes your new employers will handle the paperwork for you, but in other situations, you must take responsibility, and you must act quickly. If you've already withdrawn the money from your old account, you have 60 days from the date of withdrawal to roll the funds over into a new account.

You can also shift 401(k) money into an individual retirement account (IRA) using either a direct transfer or by withdrawing the cash and depositing it into the new IRA within 60 days.

Cashing out your 401(k) if you're fired

Quitting a job with another one lined up is one thing; you probably have your retirement planned or a new job lined up. Unfortunately, being fired may mean you're left without a clear financial plan.

Even if you are fired, you want to do everything possible to avoid taking the cash out of your 401(k) and getting hit with tax penalties. Instead, you have other options, including the following:

• Keep your money in the 401(k). Many employers allow former employees to keep their money in their plans. However, if you have less than $1,000 in your account, some employers will cut you a check for your balance. If your balance is less than $7,000 (previously $5,000), your old employer may also move your money into an IRA with ultra-conservative investments.
• Roll your money into an IRA. For many former employees, this is likely the best option. It preserves your nest egg, gives you more flexibility in directing any future savings, and allows you to avoid taxes and penalties. It's usually best to do a 401(k) rollover by having your former employer transfer the money directly to your IRA provider, which is known as a direct rollover. You can also do an indirect rollover, where you cash out your 401(k) and deposit the money into an IRA within 60 days. But you'll only have 60 days to deposit your funds into a new retirement account. Otherwise, the IRS will consider it a 401(k) distribution.
• Take the money and run. Most people younger than 59 1/2 who cash out their 401(k) and withdraw all their money will owe a substantial tax penalty that can wipe out months, if not years, of savings. There are, however, a few exceptions. Some of the ways that you can withdraw money from a 401(k) without penalty include:
  • You're older than 55.
  • You're disabled.
  • You have medical expenses that exceed 7.5% of your income.
  • You're a reservist called to active duty.
  • You cash out in equal installments spread out over your remaining life.
  • You live in an area where the IRS has specifically waived penalties because it is a designated disaster area.
  • You have a terminal illness.

Advantages of cashing out your 401(k)

The only advantage of cashing out a 401(k) is that it provides liquidity if you need it after a job loss.

However, there are far more disadvantages to cashing out your retirement plan. You will owe taxes and put your retirement at risk, so try to avoid this option by relying on an emergency fund, claiming unemployment benefits, or looking for temporary work.

Disadvantages of cashing out your 401(k)

There are two major disadvantages to cashing out your 401(k): taxes and lost earnings.

Unless you're rolling the money into a new 401(k) within 60 days or are eligible to withdraw money without penalties, taxes are likely to be the biggest disadvantage.

For example, if you cash out a $100,000 account, you stand to lose $10,000 to the government for the early withdrawal penalty, plus income taxes ranging from 10% to 37%, depending on your tax bracket. Your $100,000 safety cushion could turn out to be worth less than $60,000 and the IRS will get a huge cut.

You'll also lose out on compound earnings. One advantage of 401(k) accounts is that your investments typically make money over time, which adds value to your account.

As your savings increase over time, your earnings are reinvested and earn money. The gains from long-term 401(k) plans can often become a significant part of the total account. You'll lose this benefit if you cash out the money.

Alternatives to cashing out your 401(k)

If you leave your job, your best option will be to transfer your 401(k) from your former employer to your new one or to an IRA.

Using the cash to cover daily expenses should be a last resort, and most financial advisors strongly recommend against it.

If you are considering cashing out your 401(k) because you need money, you should explore other alternatives first, including tapping home equity or taking out tax-free Roth IRA contributions

Should you cash out your 401(k) if you quit or are fired?

Unless you meet one of the criteria for making an early withdrawal from your 401(k) or you want to move your money to a 401(k) sponsored by a new employer, it's almost never a good idea to cash out your account.

If you cash out your 401(k) after getting fired, you've not only lost a job and benefits such as an employer match, but you're also losing money in the form of early withdrawal penalties, taxes, and future compound interest.

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