Few events can disrupt your finances as quickly as an unexpected job loss. While finding your next opportunity may be your primary focus, leaving an employer can also raise important questions about your retirement savings and long-term financial plan.
From deciding what to do with your 401(k) to evaluating tax planning opportunities and reviewing your retirement timeline, the decisions you make after leaving an employer can have lasting financial implications.
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Avoid Cashing Out Your Retirement Savings After a Job Loss
When you lose your income, covering everyday expenses often becomes the immediate priority. While your retirement accounts may seem like an easy source of cash, withdrawing money from them should generally be approached with caution.
Withdrawals from tax-deferred retirement accounts may be subject to ordinary income taxes, and distributions taken before age 59½ may also be subject to a 10% federal tax penalty in certain circumstances. Beyond the tax consequences, withdrawing retirement savings may also reduce the growth potential of your retirement portfolio.
Before withdrawing retirement assets, consider whether other resources, such as emergency savings, severance pay, unemployment benefits, or non-retirement investment accounts, may be available to help meet your short-term cash flow needs.
What Should You Do with Your 401(k) After Losing Your Job?
After leaving an employer, one of the first retirement planning decisions you'll likely face is what to do with your 401(k) or other workplace retirement plan. Because a rollover or distribution can affect taxes, withdrawal options, and other aspects of your retirement plan, it's often helpful to understand your options before moving retirement assets. Depending on your circumstances, you may be able to:
- Leave the assets in your former employer's plan, if your plan allows it.
- Roll the assets into a new employer's retirement plan, if your new employer offers one and accepts rollovers.
- Roll the assets into an IRA, which may provide additional investment choices and flexibility.
- Cash out the account, although this option should generally be considered only as a last resort because it may trigger taxes and penalties while permanently reducing your retirement savings.
Each approach has potential advantages and disadvantages related to investment choices, fees, flexibility, creditor protections, and future withdrawal rules. In some cases, age may also affect your decision. For example, special withdrawal rules may be available to certain workers who leave employment at age 55 or older.
The right choice depends on your personal circumstances, financial goals, and overall retirement strategy.
Tax Planning Opportunities After a Layoff
A layoff can sometimes reduce your taxable income for the year, which may create tax planning opportunities. One example is a Roth IRA conversion.
A Roth IRA conversion is when you move money from a traditional retirement account to a Roth IRA. The amount you convert counts as taxable income for the year of the conversion, but future qualified withdrawals from the Roth IRA may be tax-free.
Because the amount you convert is added to your taxable income, how much tax you pay depends in part on your income for the year. If a layoff temporarily places you in a lower tax bracket, you may be able to complete a Roth conversion while paying less tax than you would during a higher-income year.
For some individuals, paying taxes on a Roth conversion during a lower-income year may be more advantageous than paying taxes later on future withdrawals from a traditional retirement account. However, a Roth conversion is not appropriate for everyone and should be evaluated carefully before taking action.
Changes in income may also create other tax planning opportunities. Before year-end, it may be worthwhile to review your projected income and determine whether any additional tax planning strategies make sense for your situation.
📌 Learn more - Should You Do a Roth Conversion Before the End of the Year?
Should You Change Your Retirement Timeline After You Lose Your Job?
A job loss doesn't necessarily mean you need to delay retirement. For some people, the impact may be minimal. However, if you're out of work longer than expected or stop contributing to your retirement savings, it may be worth revisiting your retirement plan.
Consider questions such as:
- Are your retirement savings still on track to support your goals?
- Has your target retirement age changed?
- Will a period of reduced retirement contributions affect your retirement projections?
- Could working longer, returning to part-time work, or adjusting your retirement spending assumptions help keep your plan on track?
Your answers can help you decide whether your retirement plan should be adjusted to reflect your current circumstances.
Additional Retirement Planning Considerations After a Layoff
Depending on your situation, there may be other retirement planning considerations worth discussing, including:
- Rule of 55: Certain workers who leave employment at age 55 or older may be able to access money in their workplace retirement plan without the typical 10% federal early withdrawal penalty, provided IRS requirements are met. Because this exception generally applies only to the employer's plan you leave, it's important to understand the rules before transferring those assets to an IRA.
- Net Unrealized Appreciation (NUA): If you hold highly appreciated employer stock in a workplace retirement plan, an NUA strategy may allow the stock's appreciation to be taxed at long-term capital gains rates when the shares are sold, rather than as ordinary income. Specific distribution requirements must be met, so this strategy should be evaluated carefully before rolling the account into an IRA.
Planning for the Road Ahead
A layoff can mean more than just losing a paycheck. The financial choices you make during this transition may continue to affect you long after you've found your next job. Taking time to understand your options may help you avoid rushed decisions and better evaluate your next steps.
If you've recently lost your job and would like to discuss how it may affect your retirement plan, we're here to help. You can schedule a complimentary introductory meeting with our team in Glastonbury or Wilton, Connecticut, to review your situation and discuss how a job loss may affect your financial future.
Have a quick question instead? Send us a note.
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Michael Nicoletti is a CERTIFIED FINANCIAL PLANNER® professional and works with clients throughout Connecticut and nationwide, offering financial planning and wealth management services. Based in Glastonbury and Wilton, CT, Michael helps families and individuals plan for their financial, insurance, investment, and retirement goals. Schedule a complimentary introductory meeting with Michael.
This information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. It is not a statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of the author, not necessarily those of Raymond James, and are subject to change without notice.
RMDs are generally subject to federal income tax and may be subject to state taxes. Consult your tax advisor to assess your situation. Contributions to a traditional IRA may be tax-deductible depending on income, tax-filing status, and other factors. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59½, may be subject to a 10% federal tax penalty.
Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. 401(k) plans are long-term retirement savings vehicles. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59½, may be subject to a 10% federal tax penalty. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.