Does 401(k) Have to Be Declared If a Person Is Laid Off?
Being laid off from your job not only means that you have to scramble to find new employment, but you also have to make decisions about your retirement accounts. You may have a 401(k) plan from your old employer as well as personal retirement accounts (IRAs). How you handle these accounts when you are laid off can affect your tax situation.
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What Happens to Your 401(k) When You are Laid Off?
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There are two main types of 401(k) plans: the traditional 401(k) and the Roth 401(k). Both are plans set up by employers for their employees. Your employer may also match some of your contributions as a job perk. When you are laid off, your 401(k) stays in place and retains its tax status unless you choose to do something with it. You have the option of leaving it where it is if the total plan is over $5,000, rolling it into a 401(k) plan with your new employer or transferring it to an Individual Retirement Account (IRA). None of these options result in having to declare your contributions in income for tax purposes. Withdrawing from your 401(k) may result in tax consequences.
Tax Consequences of Withdrawing Early From a 401(k) Plan
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If you are short of funds after you have been laid off, it is important to consult a tax professional before withdrawing money from your 401(k) plan. If you are under 60 and not disabled, you can face not only having to include the withdrawn amounts in your income, but also a 10 percent penalty. Taking money from your retirement accounts to fund your unemployment is usually the last solution. If you have a Roth 401(k), you may be able to withdraw the contributions but not the income early. If you are facing serious hardship, there are ways to apply for penalty-free withdrawals.
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Contributing to Retirement Plans When You are Laid Off
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You may or may not be able to contribute to either a 401(k) or an IRA plan while you remain unemployed. Each 401(k) plan has different rules and your plan administrator will tell you whether you can keep putting money in. You can contribute to an IRA regardless of your employment status as long as you meet the requirements. You must not be a high-income individual and can contribute a maximum of $5,000 per year ($6,000, if you are 50 or older). You also can only contribute up to your total salary for the year. This means if you are unemployed for the entire year, you will not be able to make tax-deductible contributions.
Rolling Over Your 401(k) Plan
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One of your options when you are unemployed is to roll your old employer's 401(k) plan into an IRA. A traditional 401(k) has to be transferred to a traditional IRA and a Roth 401(k) has to get transferred to a Roth IRA. While this does not give you any surplus money in the short term, it allows you to control the investments in the plan yourself. The transfer must be done with the help of a financial institution to avoid tax consequences. If you simply withdraw the money in the 401(k) and contribute it to an IRA, you may be taxed and have penalties levied on the withdrawal and bump up against the contribution limits.
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