What Not To Do with Your 401(k) if You Lose Your Job

February 25, 2013

For Immediate Release

Contact: Gigi Thompson Jarvis

202.822.6232, x119                                           

gjarvis@naea.org

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What Not To Do with Your 401(k) if You Lose Your Job

 

Washington, DC, February 25, 2013 — Perhaps you are one of the thousands who lost their jobs during this economic downturn, or you’re thinking that you might be laid off and are wondering how to plan for it. Once you’ve been laid off, you are not allowed to make contributions to your 401(k). Depending on your company’s vesting policy, it’s possible you could even lose some of the employer’s contributions that are in your 401(k).

Here are some guidelines as to what you should do with your 401(k) if you’ve lost your job according to Cynthia Jeanguenat, EA of the National Association of Enrolled Agents (NAEA).

First, don’t cash in your 401(k).  This should be your last choice. “Generally, any distribution from your 401(k) that you receive before age 59 ½ is considered an early distribution,” says Jeanguenat. “Those early (or premature) distributions are subject to a federal 10 percent early withdrawal penalty in addition to the federal and state income taxes due.” Here’s how that plays out: Let’s say you have $50,000 in your 401(k) and you are in the 25 percent federal tax bracket and have a state rate of 7 percent. The federal tax of $12,500, plus the state tax of $3,500, plus the 10 percent penalty of $5,000 will leave you with just $29,000 and a huge tax bill unless you have some tax withheld when you receive the distribution.

Second, do nothing. If you have $5,000 or more in your 401(k), it may be possible to leave your money where it is. Unfortunately, you will not be able to add money to the account, you will not receive any matching money from the company, and you will not be allowed to borrow from the account. In any case, this is a good option because the money will still grow tax-deferred.

Third, do a rollover. When you find a new job, you may be able to roll over your 401(k) to your new employer’s plan. This depends on the company and whether its plan allows for rollovers. Another option is a direct or indirect rollover to an IRA. You can roll over your money into a variety of investments, including stocks, bonds, mutual funds and CDs. A direct rollover saves you the taxes you’d incur if you cashed out your 401(k). Indirect rollovers are a little more complicated and you could end up paying taxes on part of the funds.

If you haven’t lost your job, but think you might, NAEA advises that you immediately open an emergency fund that is separate from your 401(k). Having three month’s salary saved up is always a good idea. Another must is to reduce your expenses. One good way to do that is to refinance your home. With the low interest rates in effect, now is a good time to reduce your monthly payments by refinancing.

Of course, no two situations are alike, so NAEA recommends that you contact an enrolled agent for advice on how to manage your 401(k) if you lose your job. Enrolled agents are federally-authorized tax practitioners who have technical expertise in the field of taxation and are empowered to represent taxpayers before all administrative levels of the IRS. To find an enrolled agent in your area, visit the “Find an EA” directory at www.naea.org.