How 401(k) Withdrawals Work When You’re Unemployed


If you find yourself unemployed and your savings are insufficient to tide you over until you land a new job, it’s natural to think about whether you can draw on your 401(k) funds. Case in point: the current coronavirus pandemic, which has put three million Americans out of work. Here’s a quick recap of how these retirement accounts work and the rules governing withdrawals—including news on help during the current coronavirus pandemic.

Key Takeaways

  • An employer-sponsored 401(k) plan is designed to help employees build a retirement nest egg via contributions of pre-tax earnings.
  • In response to the coronavirus pandemic, Congress has adopted new legislation that would allow withdrawals of up to $100,000 from 401(k) accounts without penalty for those affected.
  • Under normal circumstances, hardship withdrawals from 401(k)s incur a 10% penalty. But you might be able to avoid that penalty if you roll over 401(k) funds into an individual retirement account (IRA).
  • If are laid off, fired or quit in the calendar year when you turn 55 (or after that), you can access your 401(k) money without having to pay the 10% penalty.
  • Unemployed individuals can receive what is termed substantially equal periodic payments (SEPP) from 401(k) plans, with payments distributed over a minimum period of five years or until the individual reaches age 59½, whichever is greater.

How 401(k) Plans Work

401(k) Withdrawals During the Coronavirus Pandemic

Some 401(k) plans allow for hardship withdrawals based on what the IRS terms “an immediate and heavy financial need.’’ Usually, these hardship distributions are subject to the 10% early withdrawal penalty as well as taxes.

On March 27, 2020, President Donald Trump signed a $2 trillion coronavirus emergency stimulus bill into law. The CARES Act allows individuals to withdraw up to $100,000 from their 401(k) accounts and individual retirement accounts (IRAs) without having to pay the 10% early withdrawal penalty. To qualify, the person must be diagnosed with COVID-19, or their spouse or dependent has been diagnosed with COVID-19. Or, the individual must have experienced financial hardship as a result of being quarantined, laid off, furloughed or unable to work due to lack of childcare. The distribution can be spread over three years, which gives impacted individuals three years to pay the taxes on the withdrawal as well as to replace the funds.

See “401(k) Hardship Withdrawals,” below, for more on the usual rules for these withdrawals.

How to Access Funds When You’re Unemployed

Under ordinary circumstances, employment presents a series of choices for an individual who owns a 401(k). First, there’s the question of whether to keep the account with the former employer or roll it over (or directly transfer it) into an IRA. Handled correctly, a rollover IRA constitutes an in-kind transfer, where a lump sum from an employer-sponsored tax-deferred account is moved to an individual account. If the Internal Revenue Service (IRS) guidelines are followed, the transfer is not considered a taxable event.

Even if you didn’t leave on the best of terms, read the rest of this article before deciding whether to roll over your 401(k) into an IRA.

The Age 55 Rule

If joblessness lingers, individuals face a second question: What happens if you haven’t reached age 59½ and need to tap into your 401(k) to keep bills paid? There are some special options that can help unemployed workers avoid extra penalties and still gain access to some 401(k) money.

If you become unemployed in the calendar year when you turn 55 (or after that), you don’t have to wait until age 59½ to gain access to your 401(k) money without having to pay the 10% penalty. In fact, if you still have other 401(k) money at an employer you left long ago, you will also gain access to those funds. This is not true, however, if you rolled over that money into an IRA. By the way, unlike with unemployment, it doesn’t matter if you were laid off, fired or resigned.

Substantially Equal Periodic Payments

Payments are typically calculated based on the life expectancy of the account holder or the combined life expectancy of the plan participant and his beneficiaries. Distributions can be taken with any frequency during the year as long as withdrawals do not exceed the pre-calculated annual value. If the amount is arbitrarily modified, the 10% penalty exception is negated and you have to pay the penalties.

You can also withdraw money from an IRA using the SEPP method. Discuss the best approach with an advisor before you make a final decision.

401(k) Hardship Withdrawals

As noted above, 401(k) plans may allow for hardship withdrawals, which, unlike IRA hardship withdrawals, are normally subject to the 10% early withdrawal penalty.

Circumstances that qualify under IRS guidelines (if your company’s plan permits it) include certain medical expenses, costs to purchase a principal residence, amounts needed to avoid eviction from a principal residence, and tuition or educational expenses. Individuals who receive funds from qualified retirement accounts must maintain proof that the need exists.

These withdrawals are only allowed after nontaxable loan privileges have been exhausted. Furthermore, the distribution must not exceed the amount of need. If an inpatient hospital stay creates a $5,000 deductible liability, the withdrawal must not exceed the amount of the medical expense. However, the total withdrawal may be increased to $5,500, allowing for an additional amount to cover the cost of IRS taxes or penalties.

The need is not deemed to be heavy and immediate if other resources, including assets owned by a spouse or minor children, are available. Note now that the CARES Act has been signed, these rules are waived for those affected by the coronavirus.

The Bottom Line

Obviously, it’s anything but ideal to tap into retirement funds before you are actually retired. But sometimes, it can be unavoidable. Try to keep track of what you’ve spent and if you are able to find another job, make a special effort to repay what you took out into your new employer’s 401(k) if there is one. If you’re 50 or older—or when you reach that age—be sure to make additional “catch-up contributions” to your 401(k) and IRA. For the 2020 tax year, you can pay an additional $6,500 per year into your 401(k), for a total contribution of $26,000, and an additional $1,000, for a total of $7,000, into your IRA.

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