A third of employed people say they plan to look for a new job this year, and many of them are likely to make withdrawals from their 401(k) — a move financial planners almost always advise against.
Thirty-six percent of workers polled last November say they plan to look for a new job in the next 12 months, according to a workhuman survey. The survey includes 2,268 fully employed people in the U.S., U.K., Canada and Ireland as respondents.
However, many of the U.S. workers who have quit their jobs during the pandemic — a phenomenon known as the Great Resignation — say they've cashed in their savings to make it happen.
Around 21% of Americans who quit their jobs during the pandemic say they cashed out their 401(k), according to a recent Fidelity survey of 2,622 U.S. adults with at least one retirement account.
However, financial planners generally recommend that workers avoid making any early withdrawals from their retirement savings in order to let the money grow for when they actually retire.
"Cashing out of a 401(k) is probably the most tempting — yet often most devastating — action someone can take when they leave their employer," says Scott D. Schwalich, a wealth strategy advisor at Anderson Financial Strategies, LLC.
Early withdrawals before age 59½ typically trigger a 10% penalty. Plus, the withdrawal is taxed as income, which creates a potential 10 to 37% tax burden for the worker, Schwalich says. Even worse: "you can't make up for lost time," he adds. The cost of missing out on years of compound interest can drastically reduce your retirement savings, which could force you to work longer than you originally planned.
"Every client we've ever worked with wants to reach that 'work is optional' stage in life, regardless of how much they love their job," Schwalich says. "For many, cashing out of a 401(k) could cause that day to come too late."
Of course, sometimes people are forced to cash out their retirement savings to cover the cost of unexpected emergencies, like debt from medical bills. In fact, there are reasons for withdrawals that won't trigger the 10% penalty, like having a disability or needing to pay for taxes and health insurance premiums. However, the withdrawal is still taxed as income.
Make sure you have a financial plan before quitting your job
Considering the penalties, you don't want to withdraw early from a 401(k) if you can help it, especially if you're quitting your job without something else lined up.
"The labor market is in a position right now where there's a lot of power on the employee, so they should be able to get another job sooner rather than later," says Rob Greenman, a certified financial planner and chief growth officer at Vista Capital Partners. "But that's not a sure thing."
Greenman suggests putting some "guardrails" in place before leaving your current job to prevent you from needing to make withdrawals. These include a topped-up emergency fund worth three to six months of your expenses, including monthly health insurance payments, and some sort of health insurance while unemployed.
He also recommends seeking out jobs that offer "happiness and purpose," not just more money. By ensuring that a new job is a good fit, you'll be less likely to quit the role because it makes you unhappy.
"The problem with 401(k)s is that you can withdraw from them a little bit easier. For example, you can't easily take $10,000 or $5,000 out of your house," says Greenman. "I think that's why we hear about that happening more frequently."
Don't miss: Here's how much money Americans lose to online scammers at every age
The 10 most-searched jobs in the U.S., according to Google—and how much they pay
Sign up now: Get smarter about your money and career with our weekly newsletter
Based on the amount of money in your 401(k) account, your employer may allow you to leave the account with them. However, you will not be able to contribute any more to your old account.
Leaving your account with the old employer may not be prudent—especially when you have access to more flexible Individual Retirement Account (IRA) plans from most brokers. You may roll over your 401(k) account to your new employer or transfer the funds into an IRA. If you meet the age criteria, you may start taking distributions without having to pay any penalty for early withdrawal.
Do You Get Your 401(k) if You Quit?
Be aware of the following rules regarding your old 401(k) account:
If your 401(k) has a total investment of more than $5,000, your employer may allow you to leave the account with them even after you quit the job.
If your account has a balance of less than $1,000, your employer may force you out and pay the amount left in your account with a check.
If the total investment amount in your old 401(k) is between $1,000 and $5,000 and your employer wants to force you out, they must transfer the amount to your IRA.
Options for Cashing Out a 401(k) After Leaving a Job
The amount in your 401(k) account, including your contribution, your employer’s contribution, and any earnings on your investments, belongs to you and can supplement your retirement fund. The huge amount of money accumulated in your 401(k) account may tempt you to cash out your plan, but it’s in your best interest not to do so.
Leaving your account with your old employer may not a good idea. There are chances that you may forget the account after some time. You can, instead rollover to your new employer or even set up an IRA to roll 401(k) funds into.
Rolling over your 401(k) to an IRA gives you the flexibility to invest your funds the way you want. However, in some states like California, your creditors have easier access to your IRA funds than the money kept in a 401(k) account. If you see any potential claim or lawsuit against you, you may want to let your funds lie in a 401(k) account rather than transferring into an IRA.
Alternatively, if you are eligible for the 401(k) plan of your new employer, you may want to roll over your old 401(k) to your new account. No matter where you invest, always consider minimizing the risk by diversifying your portfolio. You may never want to invest a large portion of your savings in a single company, no matter how much you trust it.
How to Cash Out a 401(k) After Quitting
You may follow this type of action plan for your 401(k) when you quit your job:
If your new employer offers a 401(k) plan, check your eligibility and enroll yourself.
Once enrolled, get the funds and investments in your old account directly transferred to your new account. You can opt for a direct administrator-to-administrator transfer through simple documentation to avoid potential taxes and penalties.
Instead of direct transfer, you can also cash out your old account and deposit the proceeds in your new account within 60 days of cashing out. That way, you don’t have to pay income tax on the amount of the withdrawal (which is treated as distribution).
You must start taking 401(k) distributions after you turn 70 ½ years old and you are not working anymore. However, unlike traditional plans, in a new retirement plan with your current employer, you cannot be forced to take the required minimum distributions even after you reach the age of 70 ½.
If your new employer does not have a 401(k) plan or you do not like the plan your new employer has, you may roll over your old 401(k) account to an IRA. The rollover process is like the process of rolling over to a new account. You can either get it done directly through your plan administrator or take out the proceedings and deposit them in your IRA within 60 days.
Cashing Out a 401(k) in the Event of Job Termination
In case you are fired, you can cash out your 401(k) plan even if you are below the age of 59 ½ years. You just need to contact the administrator of your plan and fill out certain forms for the distribution of your 401(k) funds. However, the Internal Revenue Service (IRS) may charge you a penalty of 10% for early withdrawal, subject to certain exceptions.
Withdrawing From a 401(k) After Leaving the Company Without a Penalty
In any of the following situations, you may qualify for early withdrawal without being subjected to any penalty:
If you leave a company the same year you turn 55 years old
If you suffer from total or permanent disability
If you cash out in equal installments spread over an expected period of your remaining lifetime
If you need to pay for medical expenses, which are more than 10% of your income
If as a military reservist, you have been called to active duty
Tax Implications of Cashing Out a 401(k) After Leaving a Job
The following are some tax rules regarding your old 401(k):
When you leave your 401(k) account with your old employer, you won’t need to pay taxes until you choose to withdraw the funds.
Even when you roll over your old 401(k) account to your new employer, you need not pay any taxes.
At the time of your 401(k) distributions, you will be liable to pay income tax at the prevailing rates applicable for such distribution.
If you haven’t reached the age of 59 ½ years at the time of distribution, you may be liable to pay a premature withdrawal penalty of 10%, subject to certain exceptions.
Distributions from a designated Roth account are tax-free after you reach the age of 59 ½ years, provided your account is at least five years old.
Although legally, you have every right to liquidate your old 401(k) account and cash out the entire funds, doing so would reduce your savings for the retired life. Additionally, the distributions will add up to your annual taxable income.