What to do with your 401(k) after a layoff

After a layoff, you usually have time to decide what to do with your 401(k), and the safest default is to avoid taking a check made out to you. Under IRS rules, a direct rollover to an IRA or a new employer's plan has no tax withholding, while a payout sent to you is subject to mandatory 20% withholding and may owe a 10% additional tax if you are under 59½. Plan rules differ, so confirm details with your plan administrator and a tax professional. This guide is general information, not tax or legal advice.

Can I take money out of my 401(k) after I lose my job?

Often yes. The IRS 401(k) resource guide lists severance from employment as one of the events that allows distribution of elective deferrals. Whether you can take a lump sum or installments depends on your plan's terms.

Key points from the IRS:

Larger balances: if your account is over $5,000, the plan administrator generally must get your consent before distributing it.
Smaller balances: if a distribution over $1,000 is made and you do not choose to take it or roll it over, the plan may move it to an individual retirement plan and must tell you in writing.
Not everything qualifies: some distributions, such as hardship distributions and required minimum distributions, cannot be rolled over.

What are my options for the money?

The IRS rollover guidance describes three paths:

Direct rollover: your plan administrator pays the money straight to another plan or an IRA. The IRS says no taxes are withheld from the transfer amount.
60-day rollover: the payment comes to you, and you deposit it into an IRA or plan within 60 days of receiving it. The IRS may waive the deadline for circumstances beyond your control.
Keep the cash: the distribution is generally taxable, except for qualified Roth distributions and amounts already taxed, and it may carry a 10% additional tax.

Some plans also let a former employee leave the money where it is. Ask your plan administrator whether yours does, and request the Summary Plan Description if you have not seen it. The Department of Labor's job loss guidance recommends asking for it along with an individual benefit statement.

What is the 20% withholding trap?

If a retirement plan pays you directly, the IRS requires 20% to be withheld, even if you plan to roll the money over. The IRS example: on a $10,000 distribution with $2,000 withheld, rolling over only the $8,000 makes the $2,000 taxable, and it may also face the 10% additional tax. To roll over the full $10,000 within 60 days, you would have to add the $2,000 from other funds.

A direct rollover, or a check made payable to the receiving plan or IRA, avoids this withholding.

Will I owe the 10% early withdrawal tax?

Possibly. According to IRS Topic 558, the additional tax is 10% of the portion of an early distribution that counts as income. Early distributions are generally those received before age 59½.

There are exceptions. One applies if you separated from your employer in or after the calendar year you turned 55. The IRS also lists a separate age-50 rule for certain public safety employees in governmental plans. Other exceptions exist, and they have conditions, so check the IRS list of exceptions to the tax on early distributions before you rely on one.

Even when the 10% tax does not apply, a taxable distribution still adds to your income for the year.

What should I do first?

You do not need to move the money in the first days after a layoff. A practical order:

Get the facts: ask your plan administrator for your balance, your plan's distribution options and any forms or deadlines.
Update your contact details: make sure the administrator can reach you after your work email is shut off.
Choose a direct transfer if you move it: have the money sent plan to plan or plan to IRA, not to you.
Weigh the cash need: if you must take a payout to cover expenses, ask a tax professional what you may owe first.

Our first 48 hours checklist covers the other deadlines to track, including health coverage and unemployment benefits. Before signing a separation package, see what to ask for in a severance agreement.

What to watch

The two details that most often cost people money are the 20% withholding on a payout made to you and the 60-day rollover clock. Both are avoided by asking for a direct rollover. If you are worried about more cuts at your employer, you can check a company or browse the live layoff feed.

Sources

Sources are linked inline. Figures come from company filings with the SEC and state WARN notices. How we source.