More than 22 million jobs have been lost since the coronavirus pandemic shuttered businesses across the country this spring.
If you’re among the millions of Americans who’ve lost a job, and were fortunate enough to have an employer-sponsored 401(k) plan, what to do with that money is a common question—especially if you’re struggling financially.
Here are some options and what to consider before you take the next step.
Leave the account alone.
If your 401(k) investment balance is more than $5,000, most plans allow you to just leave it where it is. This is often the simplest choice. If you don’t urgently need the money, leaving your 401(k) account alone allows it to continue growing from investment gains.
It may make sense to roll over the 401(k), though, if you’re paying high fees for the management of the account where it is, or if you want more control over how your money is invested.
If the account balance is less than $5,000, your old company may also opt to distribute the money to you. Then it’s largely on you to roll it over into a new retirement account if you want to avoid having to pay taxes on it now—and possibly a penalty. (If you need the money to stay afloat, you may also choose to keep it. We’ll cover that below.)
Roll your old 401(k) over into a new 401(k)
If you’ve since gotten another full-time job (the U.S. has regained about half of the jobs lost in the pandemic) and have access to an employer-sponsored retirement plan, you can streamline your plans by rolling over your old 401(k) into your new one. You can request the administrator of your old plan deposit the money from your account directly into the new plan by filling out some paperwork. This is called a direct transfer, as it’s made from custodian to custodian, and it saves you the risk of owing taxes.
You do have the option to elect instead to have the balance of your old account distributed to you by check. But then the onus is on you to deposit those funds into your new 401(k) within 60 days to avoid paying income tax on the whole balance. So, if you go this route, be sure your new 401(k) account is active and set up to receive contributions before you cash out your old account.
Roll over your 401(k) into an IRA
If you haven’t gotten another full-time job, or your new job doesn’t offer access to a 401(k) plan, you can roll over your old 401(k) into an Individual Retirement Account (IRA) instead.
The biggest benefit of using an IRA is that you have more investment options than you would with a 401(k). You can shift your investments anytime, and typically have a range of choices to invest in, including individual stocks, corporate and government bonds, exchange-traded funds and mutual funds. If that flexibility is important to you, you may choose to do this even if you do have a new 401(k) plan.
If you already have an IRA, you can roll over the funds from your old 401(k) directly into it. Or you can open an IRA through whatever financial institution you choose, and then request your old 401(k) be rolled over into it.
Again, if your old employer has sent you a check, you’ll be responsible for then depositing those funds into the IRA within 60 days to avoid paying taxes on the distribution.
Cash out your 401(k)
If you seriously need the funds now to make ends meet, you may prefer to cash out your 401(k)—or to withdraw some of the funds. If so, you wouldn’t be alone. A Bankrate survey in late May found that more than 27 percent of those working or recently unemployed had already taken a withdrawal from their retirement accounts or planned to do so.
The CARES Act, passed this spring, makes it easier to tap your retirement account if you’re suffering financial hardships as a result of the coronavirus pandemic. But that doesn’t necessarily mean it’s the best idea. Here’s what to consider.
What taxes will you owe?
If you have a traditional 401(k) account, you have to pay income tax at your ordinary rate on any distributions you take. Ordinarily, you would also have to pay a 10 percent penalty if you’re under the age of 59 1/2 for taking money out. But the CARES Act has waived the usual penalty for those who lost household income as a result of the coronavirus pandemic for money withdrawn from a retirement account before December 30, 2020.
Initially, the CARES Act provision waiving the usual penalty for early withdrawal of retirement funds only applied to people directly affected by the coronavirus. But the IRS later expanded the definition of who qualifies to tap funds in a 401(k) or other employer-sponsored retirement plan, or an IRA.
It now also includes anyone who’s experienced negative financial consequences as the result of a spouse or a member of the household (someone sharing the principal residence) being diagnosed with the coronavirus or losing income or a job as a result of the coronavirus pandemic. That means that you would qualify if, for example, you or your spouse was laid off or has seen work hours reduced, or lost business (or had to close a business), because of the virus. You may also qualify if you had to stop working or cut work hours because of a lack of childcare during the pandemic.
How much money do you need?
The CARES Act allows any qualified individuals who’ve been negatively affected by the coronavirus pandemic to withdraw up to $100,000 from eligible retirement plans until December 30, 2020, and avoid the usual 10-percent penalty.
You will also have three years to pay the federal taxes on money withdrawn this year. For example, if you take a $15,000 coronavirus-related distribution in 2020, you could report $5,000 in income on your federal income tax returns for each of the 2020, 2021, and 2022 tax years. (You also still have the option of including the entire distribution in your income for 2020 and paying taxes then.)
If you do opt to withdraw some of your funds, you’re best off only taking what you absolutely need to stay afloat. Withdrawing retirement funds early means that they miss out on growth. And, even though you won’t have to pay a penalty, you will generally still have to pay taxes on that withdrawal.
Do you have other sources for funds?
If you do have savings or other sources of funds, it may make more sense to tap them instead of using money from that 401(k).
If you also have a Roth IRA, for example, you can withdraw any contributions you’ve made tax- and penalty-free. If you rollover your 401(k) or leave it where it is, you may also have the option to borrow from it, which can help you avoid paying taxes.
Should you borrow from your 401(k)?
If you can, borrowing money from your 401(k) is a better idea than withdrawing money from it, or cashing it out. A June poll by the American Consumer Credit Counseling, a nonprofit credit counseling agency, found 22 percent of Americans surveyed have already borrowed from their retirement account this year.
The IRS allows loans of up to $50,000 or 50 percent of your vested balance, whichever is less. Generally, the loan must be repaid within five years. If you pay it back on time, you won’t owe taxes on the money your borrowed. (Payments must also be made in substantially equal payments that include principal and interest and be paid at least quarterly, according to the IRS.)
Before you borrow, be sure you can pay all of the money back within the repayment period. Loans considered in default may be treated as a taxable distribution from the plan, so you could owe taxes for the entire outstanding balance of the loan.
But if you’re confident you can pay it back, borrowing is a better option than withdrawing funds or cashing out if you can swing it. You generally won’t owe taxes if you repay the money on time. And by replacing that money, you lessen the impact on the growth of your retirement savings.
The IRS Has Made It Easier To Make 401(k) or IRA Early Withdrawals—But Should You?
How to Keep Your 401(k) On Track During the Covid-19 Crisis