Do I dump the 401(k) when the pink slip comes?

By dave thomas

Your choices in a layoff are relatively simple: keep the 401(k) money in the current plan, cash out the plan altogether or roll the funds over into a traditional or Roth IRA.

Whether you knew the layoff was coming or it caught you by surprise, many emotions will run through your mind.

Thinking straight during a company layoff is not always a guarantee, so any financial decisions at this time should be made only after you’ve had a chance to digest everything. Once you have, you will have some important decisions to make, one of which may be whether or not to do away with the 401(k) you had at your former employer.

The choices in a situation like this are relatively simple: keep the 401(k) money in the current plan, cash out the plan altogether or roll the funds over into a traditional or Roth IRA.

Whether you’re working with a financial adviser or winging it, there are several factors to keep in mind when determining your 401(k)'s fate:
  • Is it best to leave the money where it is?

    While some individuals may decide to just let the money sit where it is, do they really want to still have a connection to the company that let them go? The biggest hassle is to have to connect with someone in the company when you need assistance with the plan.

    Unless you remain friends with that individual, getting answers to any questions on your 401(k) could prove difficult. Throw in managing an added account (your former employer may also close the account and mail you a check), and most people will either transfer or close out their former employer’s plan.

  • Is it best to cash it out?

    Should you decide to cash out the plan and not note a qualified retirement account, the IRS mandates your former employer forward one-fifth of the funds to the government. Once you have the funds mailed to you, you only have 60 days with which to deposit the money into another qualified plan, or face taxes.

    In the event your account has less than $1,000 in it, your former employer will terminate it and forward you a check for the balance. You very easily could leave the check sitting around in your home, forget about it and then end up giving the IRS more money. Once again, an option many people would like to avoid.
  • Is it time to roll it over?

    The option many individuals choose following a layoff is rolling their 401(k) over into another qualified retirement plan. Whether you go direct or indirect, this decision is favored by many financial experts.

    With the direct rollover, you avoid taxes and other penalties. The check will be sent straight from the holder of your current plan (your former employer) to the holder to be for the new plan.

    When doing an indirect rollover, you receive the check, but with 20 percent removed for the IRS. Then you must rollover that money into the new IRA within 60 days, matching the original amount you had previously with the old plan. When doing this, you will get the 20 percent returned when you do your taxes.
Some other tidbits to think over:
  • As for investment opportunities, individuals can look to a number of areas to invest the funds from a former 401(k) plan, including stocks, bonds, mutual funds, CDs, treasuries, futures, commodities, real estate and more.

  • Ten percent of the untaxed money you withdraw, along with applicable federal, state and local taxes on that amount are factored into the penalty figure if you take money out of your 401(k) prior to turning 59½.

  • Finally, should the company you’ve worked for go bankrupt, all the contributions allocated to a 401(k) account are placed in a custodial trust that is separate from the company sponsoring the plan. The vested figure of funds in your account will remain yours.
When it comes to layoffs, your 401(k) may not be at the top of your list of concerns, but it should be an important matter that will be dealt with sooner rather than later.