Check your options and ask about the CARES Act before making any 401(k) decisions after a job loss.
If you've been laid off, furloughed or let go from a job, your entire financial plan can change overnight. For many Americans, that switch to unemployment is becoming a reality in the wake of the coronavirus pandemic: more than 10 million workers filed for unemployment benefits during March 2020, according to U.S. Department of Labor data. With economic uncertainties looming, that figure could increase in the coming months.
When facing a job loss, it can be natural to look at money set aside for retirement. If you had a 401(k) with your former employer, you'll need to decide what to do with the funds in the account. There are several options to consider, but each one comes with potential benefits and costs.
Here's what you can do with a 401(k) if you are laid off during the coronavirus crisis:
|-||Leave the money in your 401(k) if you have more than $5,000.|
|-||Move the funds into an individual retirement account or 401(k) plan at a new job.|
|-||Withdraw up to $100,000 penalty-free, but income tax must be paid on the distribution over three years.|
Read on to learn about your 401(k) options after losing your job, along with criteria to think through before making any moves.
Look at Your 401(k) Balance
The amount in your 401(k) can impact the options available. "If your account balance is below $5,000, your employer has the option of removing you from the 401(k) plan by distributing the funds," says David McCormick-Goodhart, a financial advisor at Savant Capital Management in McLean, Virginia. For balances above $5,000, the employer will need to leave the funds in the 401(k) unless you ask for the amount to be removed.
If you're not sure how much you have accumulated, check the balance of your account. For balances that are under the $5,000 threshold, you can ask your employer if the company plans to distribute the funds, or if another policy is in place.
Consider Leaving the Money in Your 401(k) Account
If your account balance is above $5,000, you may decide to keep the 401(k) plan with your former employer. You won't be able to keep contributing to the plan, but the invested money could grow over time.
Leaving the 401(k) funds at the company where you used to work could lead to some drawbacks. "You are limited to the investment options that are available in the 401(k) plan," McCormick-Goodhart says.
You could also face the uncomfortable situation of having to communicate with a former employer to ask for an address or beneficiary change. "You may need to go through the employer's human resources department to obtain the necessary paperwork, which can be both inconvenient and awkward after a job loss," McCormick-Goodhart says.
Move the Funds to an IRA or Another 401(k) Plan
If you have another job in place, you can ask your new employer if a 401(k) plan is available. If so, "roll over your 401(k) into your new employer's plan," says David Ragona, director of retirement operations at Human Interest in San Francisco. Also ask about any available matches. If the employer agrees to match contributions up to a certain amount, you'll be able to save even more toward retirement.
You could also choose to roll over the 401(k) into an IRA. "A possible advantage of rolling your 401(k) into an IRA is that you may have more investment options," says Ted Schmelzle, senior director of retirement solutions at Securian Financial in St. Paul, Minnesota.
At the same time, you could lose money during the transition, as you would have to sell the investments in your 401(k) and repurchase them for your new IRA. This move will mean you will be out of the market for a period. "In times of market volatility, it has often been better to leave your investments alone and let your account ride out the ups and downs," Schmelzle says.
Withdraw From the 401(k) Account
If you need funds to help cover costs like a mortgage payment and groceries, you might be considering taking money from a 401(k) account. "While it may be tempting to cash out your 401(k) after leaving your job, proceed with caution before doing so," McCormick-Goodhart says. "These accounts are meant to be a vehicle for long-term retirement savings, so cashing out after a job loss can jeopardize your financial plan in the long run."
Using 401(k) funds now to pay for immediate expenses could mean that later, when facing retirement, you don't have that same amount available. The funds in the account also won't be given a chance to grow during the next decades to build up a nest egg for retirement.
Taking money from a 401(k) typically leads to penalties and taxes, but the Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act, which passed on March 27, 2020, may help alleviate some of these costs. Prior to the law, if you were not yet 55 years old, you would face a 10% penalty on the amount taken out of a 401(k) after leaving your job. The withdrawal would also be considered taxable income for that year.
The CARES Act addresses the COVID-19 crisis and offers temporary adjustments to 401(k) withdrawals. "The CARES Act allows you to withdraw up to $100,000 from your 401(k) without paying a 10% penalty, provided the distribution meets certain criteria," Schmelzle says.
The CARES Act also allows you to spread out the tax impact of the withdrawal over the next three years. If you pay back the money within three years you can avoid having the distribution marked as taxable income, leading to further savings.
It's best to check with your employer regarding the CARES Act before taking any money from your 401(k) account. "Employers are not required to adopt the CARES Act provisions, though we expect the vast majority to do so," Schmelzle says.
If your former company does apply the provisions of the CARES Act, you'll need to show that you have been impacted by the coronavirus pandemic to be eligible for the exceptions offered by the law.
Think carefully about your financial future before initiating a loan or hardship withdrawal from a 401(k). "Taking money out of the market now, when it's at a low, will lock in your losses," Ragona says. If you can gather funds from other sources and keep a stash in your 401(k), you could recover those losses in the coming years and even make gains.
"After the 2008 financial crisis, people were met with the same decision, and those who stayed in the market experienced financial recovery from their losses," Ragona says. Rather than taking money from the 401(k), you may be able to use money from a different savings account, get a personal loan or receive help from the government.