If you are laid off from your job, you may be facing financial hardships -- and eyeing every potential source of funds, including your retirement accounts. If you have a pension, 401(k), or other retirement plan through your former job, the rules on how and when you can get the money depend on the terms of the plan. Not all plans allow for early withdrawals (before you reach retirement age), and those that do may impose a penalty if you take your money out early.
Retirement plans, whether pensions, IRAS, 401(k)s, or profit-sharing plans, can be divided into two basic types: defined benefit plans and defined contribution plans.
Defined Benefit Plans
A defined benefit plan promises employees a set benefit when they retire, either as a dollar amount (for example, $400 a month) or as a formula that takes into account prior earnings (for example, a percentage of your earnings in your highest-paid year per month).
Whether you can withdraw money from a defined benefit plan when you are laid off depends on the terms of the plan. Many defined benefit plans don’t have an option for early withdrawal under any circumstances; you must reach the plan's retirement age to start collecting benefits, with no exceptions. To find out whether your defined benefit plan allows you to withdraw funds after a layoff, you'll need to review the plan documents, including the summary plan description. (You can get a copy from your plan's administrator.)
Defined Contribution Plans
Once upon a time, defined benefit plans were the norm. These days, however, defined contribution plans are more common, particularly the 401(k) plan. In a defined contribution plan, you aren't guaranteed a set amount when you retire. Instead, you (and perhaps your employer) contribute a set amount into the plan. How much you get at retirement depends on how much you (and your employer) have put into the plan and how that money has been invested.
If you have a 401(k) plan, it will set the rules for early withdrawals. Most 401(k) plans allow participants to withdraw money without paying a penalty once they reach the age of 59 and a half; employees who are laid off, are fired, or quit their jobs and are at least 55 years old may also withdraw money without paying a penalty. You may also be able to withdraw money without penalty for certain types of hardships, such as emergency medical expenses. (If you are subject to the penalty, you will have to pay 10% of the amount you withdraw to the IRS, in addition to your regular taxes.) Again, you should review your plan documents, available from the plan administrator, to find out what your plan allows.
Other Financial Consequences of Early Withdrawal
If your plan allows for early withdrawal, there may be financial consequences. As explained above, you will likely have to pay a penalty of 10% of the amount you withdraw early from a 401(k) plan, unless you are at least 55 when you lose your job. In addition, you will have to pay regular income tax on the money you take out. If you withdraw from your 401(k), the plan is commonly required to withhold 20% of the withdrawal for taxes. (Because a 401(k) is a tax-deferred account, you didn't have to pay income tax on this money when you earned it in the first place, and you don't have to pay tax on the income the account earns from investments as you earn them; instead, you pay tax when you withdraw the money.)
There are other financial drawbacks to early withdrawals as well. At the most basic level, every dollar you take out now is a dollar you won't have available to you when you reach retirement age -- and you'll also lose whatever you would have earned on that investment if it had remained in your account. There may be other consequences, too. Your best course of action is to get some advice from a financial planner before you take money out of retirement accounts.