Laid off: what happens to your retirement accounts and benefits

A layoff raises immediate questions about income and health insurance, and slower ones about retirement savings. The retirement accounts are usually the least urgent part. Money that is vested in a workplace plan does not disappear when a job ends, and most of the decisions about it can wait until the more pressing items are settled.

Income first: unemployment benefits and severance

Unemployment insurance is run by the states. USA.gov explains that each state sets its own eligibility rules and pays its own benefits, and that in most cases a claim is filed in the state where the person worked. The state agency's website explains how and when to file.

For federal tax purposes, unemployment compensation is generally included in income. Tax is not withheld automatically. The IRS says a recipient can choose to have federal income tax withheld by filing Form W-4V, or may have to make quarterly estimated tax payments. The total paid for the year is reported on Form 1099-G.

Severance pay is also taxable. IRS Publication 525 states that severance payments are included in income and are wages subject to Social Security and Medicare taxes and income tax withholding. State rules differ on whether and how severance affects unemployment benefits.

Health coverage

HealthCare.gov describes two main options when job-based health insurance ends.

COBRA continuation coverage lets a former employee stay on the employer's plan for a limited time, usually 18 months. The former employee usually pays the full premium, including the part the employer used to pay, plus a small administrative fee.

A Marketplace plan is the other route. Losing job-based coverage qualifies a person for a Special Enrollment Period, and the application must be made within 60 days of losing that coverage. Depending on estimated income for the full calendar year, a household may qualify for premium tax credits, or for Medicaid.

The two options interact. HealthCare.gov notes that a person who has elected COBRA can switch to a Marketplace plan during the annual Open Enrollment Period, or outside it if still within 60 days of losing the job-based coverage or when COBRA runs out. Voluntarily dropping COBRA early does not, by itself, open a new enrollment window.

What happens to the 401(k)

The account stays where it is until its owner or the plan does something with it. A few points are specific to a job ending.

Vesting. A worker's own contributions are always theirs. Employer contributions that have not vested under the plan's schedule may be forfeited.

The four options. The balance can generally be left in the plan, moved to a future employer's plan, rolled into an IRA or withdrawn. The guide on old 401(k) options compares them. There is generally no deadline that forces a quick decision, although plans may move very small balances out on their own.

Plan loans. A plan may require an outstanding loan to be repaid in full when employment ends. An unpaid balance is treated as a distribution and is generally taxable. The IRS notes that the tax can be avoided by rolling over the unpaid amount to an IRA or another eligible plan by the due date, including extensions, of the tax return for that year.

Taking money out early

When income stops, a retirement account can look like the obvious place to turn. The tax cost is worth understanding first.

A withdrawal from a traditional 401(k) or IRA is generally taxed as ordinary income. On top of that, the IRS applies a 10% additional tax to most distributions taken before age 59½, unless an exception applies. A plan paying a distribution directly to the individual also usually withholds 20% for federal income tax.

A hypothetical example: suppose a 45-year-old withdraws $20,000 from a traditional 401(k) and no exception applies. The additional tax is $2,000. The $20,000 is also added to that year's taxable income, and the regular income tax on it depends on the person's bracket. The amount available to spend is less than the amount withdrawn.

Two exceptions on the IRS list are especially relevant after a layoff.

• Separation from service at 55 or later. Distributions from a workplace plan are not subject to the 10% additional tax if the employee leaves that job during or after the year they reach age 55. This applies to the employer plan and not to IRAs, so rolling the money into an IRA first gives up the exception.
• Health insurance premiums while unemployed. IRA distributions, but not plan distributions, are exempt up to the amount paid for health insurance by someone who received unemployment compensation for 12 weeks.

Regular income tax still applies in both cases. The post on early withdrawal exceptions and the rule of 55 goes through the full list.

Unemployment benefits, severance and retirement withdrawals can all land in the same tax year, and the combined income can affect both the tax bill and eligibility for Marketplace savings.

Other benefits to check

• Pension. A vested pension benefit earned so far generally remains payable at retirement age. The plan can provide a statement of the accrued benefit.
• Health savings account. An HSA belongs to the individual and stays with them. See HSA basics.
• Flexible spending account. Unused balances are often lost once employment ends, subject to the plan's deadlines for submitting claims.
• Life and disability insurance. Group coverage usually ends with employment, and some policies offer a short window to convert to individual coverage.

The general changing jobs checklist covers what to review when the next job begins.