How to Cash Out a 401k When Terminated

It might not be the first question you ask when you've lost a job, but it's an important one: How do I cash out my 401(k)? More than 17 million Americans were laid off in 2022, the last full year for which data are available. So whether you're laid off, terminated, restructured, fired, or have just plain quit, it's important to read about your options for dealing with a significant part of your retirement nest egg.

Can you keep it?

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

Generally speaking, you'll be able to keep your money in your former employer's 401(k) when you quit -- with some important caveats. First, keeping your money in the 401(k) is about all you'll be able to do. You won't be able to continue making contributions since it's money that's taken from your paycheck, and you also won't receive additional employer-matched 401(k) contributions. Your employer isn't interested in paying you if you're not working there, and they're not going to be interested in paying to make your retirement more comfortable, either.

The second major caveat involves vesting. Typically, employees have to work for a certain period of time before an employer will match any part of their 401(k) contributions. Employer matches are a big part of the success of 401(k) accounts; for example, if you contribute a set percentage of your paycheck to a 401(k), your employer will match the contribution up to a certain limit, such as 3% or 5% of your salary.

The matching funds, however, usually come with strings attached. Employees are often required to work for a company for a certain amount of time before they own those matching funds. For example, if your employer sets a vesting period of one year and you quit or lose your job before then, you lose the matching funds that they contributed. On the bright side, if you work for more than a year (or however long their vesting period is set), you get to keep that money.

Cashing out after quitting

Cashing out your 401(k) after quitting your job

If you've suddenly lost your job, your first instinct might be to simply cash out your 401(k) and take the money. But it's probably a different story if you've quit and have another job lined up or if you're thinking about just opting out of the workforce.

Let's assume you're going to a new employer. Here's what you need to do:

• Check your eligibility. Most employer-sponsored plans will require you to work there for a certain period of time before you're eligible to participate in their 401(k). It may take even longer for them to match your contributions and still longer for those matching contributions to be vested. But first things first: Make sure you can participate in your new employer's plan.
• 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. Some new employers will handle the paperwork for you; others will need you to work with your former employer. You'll have important paperwork to keep to avoid tax penalties. If you've already withdrawn the cash from your old account, keep in mind that you have 60 days from the date of withdrawal to roll the funds over into a new account.
• Consider your options. You don't have to withdraw money from your old employer's account unless you're older than 73, which is when required minimum distributions (RMDs) begin. But if you're still working at that age, you can also just roll your former account into a new employer-sponsored account.

You can also shift 401(k) money into an individual retirement account (IRA), either via a direct transfer or a cash withdrawal followed by IRA creation within 60 days. Keep in mind that even if the performance of a company's 401(k) isn't as good as you'd like, it's still possible that matching funds from a new employer will make up for sub-par performance or even exceed it.

Cashing out if you're fired

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. Being fired -- laid off, terminated, restructured, or any other form of unexpected job loss -- can cause even the most prepared former employee to take a hard look at their financial situation.

Let's assume you don't yet know what you're going to do for work after losing your job. Fortunately, you have a few options here, as well:

• Keep your money in the 401(k). Many employers allow former employees to keep their money in their plans. But 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 shift money into a conservatively run IRA.
• Roll your money into an IRA. For most former employees, this is likely the best option. It preserves your nest egg, gives you a bit more flexibility in directing any future savings, and remains tax-free. Again, a 401(k) rollover can be handled either by your former employer, or you can simply cash out your 401(k) and deposit the money into an IRA within 60 days.
• 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 are more than 10% of your income.
  • You're a reservist called to active duty.
  • You cash out in equal installments spread out over your remaining life.
  • You want to use $10,000 to purchase a first home.
  • The IRS has specifically waived penalties for disaster areas.
  • You have a terminal illness.

Advantages

Advantages of cashing out your 401(k)

Although prematurely cashing out a 401(k) has major disadvantages, there are some perfectly good reasons for draining an account when you've lost a job, especially if it's an unexpected event. Not everyone has an emergency fund that they can use to pay for housing, food, and any bills that can stack up during prolonged unemployment. So, the obvious advantage of taking money from your 401(k) is that it gives you some degree of liquidity. It won't take the sting out of a job loss, but even after paying hefty taxes, it can ease the pain slightly.

Although prematurely cashing out a 401(k) has major disadvantages, there are some perfectly good reasons for draining an account when you've lost a job, especially if it's an unexpected event. Not everyone has an emergency fund that they can use to pay for housing, food, and any bills that can stack up during prolonged unemployment. So, the obvious advantage of taking money from your 401(k) is that it gives you some degree of liquidity. It won't take the sting out of a job loss, but even after paying hefty taxes, it can ease the pain slightly.

Disadvantages

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 it into a new 401(k) within 60 days or have become eligible to withdraw money without penalties, the tax issue is likely to be the biggest disadvantage. Assuming you don't have another job lined up, you'll have even less financial security than you might have imagined since your former employer is likely to withhold federal taxes, and the government will charge you an extra 10%.

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 between 10% to 37%, depending on your tax bracket. Your $100,000 safety cushion could turn out to be worth less than $60,000.

There's also the issue of compound earnings. One of the advantages of 401(k) accounts is that your investments typically make money over time, which adds to the amounts contributed both by you and your employer. As your savings increase over time, your earnings are reinvested and earn money, as well. The gains from long-term 401(k) plans can often become a significant part of the total account.

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Alternatives

Alternatives to cashing out your 401(k)

If you quit your job, the best option for most people will be to transfer the 401(k) from their former employer to their new one. Using the cash to cover daily expenses should be a last resort, and most financial advisors will strongly recommend against it.

Unfortunately, there aren't all that many great options if your 401(k) is your primary source of savings. Other options, however, might include tapping any home equity, taking out tax-free Roth IRA contributions (you've already paid taxes on them), and withdrawing money from your 401(k) if you're 55 or older and suffer a job loss, although you will have to pay taxes on those withdrawals.

Should you do it?

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 great idea to cash out your account. If you're fired, you've not only lost a job and benefits such as an employer match, but you're also losing money from the account itself in the form of early withdrawal penalties, taxes, and potential compound interest.

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