When you switch jobs, it can be a hassle to roll over your old 401(k) into your new employer's account. Once you stop contributing to your old plan, your account becomes inactive, although the money in the account can continue to grow (or decline) in value. You can usually make partial withdrawals from inactive 401(k) plans, but be prepared to lose a chunk of change to taxes.
401(k) Withdrawal Process
401(k) plans are arranged through your employer, but an investment firm actually manages the account. Once you've left a job, you normally have to contact the investment firm directly if you want to withdraw money from the account. You can request to withdraw funds over the phone, but you have to follow up the request by emailing or mailing a written withdrawal request to the investment firm. The fund custodian sells some of the shares in your account, and it usually takes a few days before you receive your money via check or direct deposit.
Impact on Your Taxes
Your contributions to 401(k) are deducted from your paycheck on a pre-tax basis. Funds inside the account are sheltered from taxes until you make a withdrawal. At that time, you have to pay federal income tax on both your original contributions and your account earnings.
If your employer put any money into your account, then you also have to pay income tax on those funds. If your state has an income tax, then you lose even more of your money. Worse still, you have to pay a 10 percent federal tax penalty if you make a withdrawal from an active or inactive 401(k) before you reach the age of 59 1/2.
Partial Withdrawal Rules
When you leave your job, your employer may require you to immediately rollover or withdraw your 401(k) funds. Some employers allow you to keep your funds in an inactive 401(k) indefinitely as long as you maintain a minimum balance. Rules vary, but this minimum is often set at $5,000.
You can make a partial withdrawal, as long as you will still have $5,000 left in the account. If your withdrawal will cause the balance to fall below this amount, then you will have to withdraw all of the funds in the account. If you don't need all of the cash, you have 60 days to roll some of it into another 401(k), or an Individual Retirement Account. When you do this, you protect the tax-deferred status of that portion of your money.
Taking Hardship Withdrawals
401(k) plans often include a provision for hardship withdrawals. Your employer decides on the criteria for a qualifying hardship. You normally have to pay both income tax and the 10 percent penalty when you make a hardship withdrawal. However, the Internal Revenue Service waives the 10 percent penalty if you make a partial or full withdrawal to cover certain costs, such as court-awarded child support payments and some medical expenses.
You can also avoid the penalty if you arrange to make a series of partial withdrawals that are designed to last for at least five years and until you are 59 1/2 years old.
Roth 401(k) Provision
Some 401(k) plans include a Roth provision, which means you pay income tax on your contributions before the money goes into the account. This can make a huge difference when you make a withdrawal, because you only have to pay taxes and penalties on your actual earnings. However, Roth 401(k)s have a five-year seasoning requirement. This means you do have to pay the 10 percent tax penalty on your contributions if you make a withdrawal within five years of establishing the account.