Your 401(k) after a layoff: leave it, roll it over or cash it out

After a layoff, the 401(k) you built over a career suddenly needs a decision. Severance may be running out, the job search may take longer than you'd like, and the balance can look like the easiest money you have.

That pull is normal. In twenty years of coaching people through job loss at FirstSourceTeam, we've watched plenty of careful savers feel it in the first month, usually while they're also worried about health insurance and the search. Feeling it isn't a mistake. Acting on it before you know the tax cost can be.

The money can stay in the old plan, move to an IRA or a new employer's plan, or come out as cash. The IRS sets the tax rules for each, and they're the same for everyone. Which one fits is your call; the sections below lay out the rules and the costs so the trade-offs are visible before you sign anything.

Vanguard's How America Saves 2026, which covers nearly five million participants in plans it runs, shows what people actually did. Of participants who left an employer in 2025 and could take a distribution, 46% left the money in the plan, 25% rolled it over and 28% took a cash lump sum. Cash-outs were a bigger share of people than of money: 28% of participants, but 5% of the assets available for distribution.

Option	Tax withheld when paid	Income tax	10% additional tax before 59 1/2	Deadline
Leave it in the former employer's plan	None	None until withdrawn	Separation in or after the year you turn 55 is an exception for this plan's payouts	None if the balance is above $7,000, though plan rules vary (about 2% of Vanguard plans require leaving by 65 or 70); plans may cash out or auto-roll smaller balances
Direct rollover to an IRA or new employer plan	None	None until withdrawn	Age-55 separation exception does not apply to IRA withdrawals	None; plan pays the new account directly
Check paid to you, rolled over within 60 days	20% withheld	On any amount not rolled over	On any amount not rolled over, unless an exception applies	60 days from receipt
Cash out	20% withheld	Whole taxable amount is income for the year	Applies unless an exception applies	None

Note: Applies to pre-tax 401(k) money. Roth balances and after-tax contributions follow different rules; see Publication 575. Publication 575 and 560 text is from the 2025 editions, current as of October 2026.

Exhibit 1. Source: IRS Tax Topic 413 (Rollovers from retirement plans); IRS Tax Topic 558 (Additional tax on early distributions); IRS Publication 575 (2025); IRS Publication 560 (2025), involuntary cash-out limit; Vanguard How America Saves 2026, Figure 114

Leaving the money in your former employer's plan

You can usually leave a balance where it is. Vanguard reports that every plan it administers allowed former employees to defer distributions in 2025, and about 2% required them to leave by age 65 or 70.

We tell clients there's rarely a reason to decide this in the first week. Unless the balance is small, the plan can't move it without your consent, so the clock is yours.

Small balances are the exception. IRS Publication 560 says a plan may pay out a former employee's benefit without consent if its present value is $7,000 or less, and must roll any such cash-out above $1,000 into an IRA unless you choose otherwise. In 2025, 54% of Vanguard plans cashed out balances under $1,000 and automatically rolled balances between $1,000 and $7,000 into an IRA.

Staying put has one feature that counts most for people in their mid-50s, covered below: the age-55 exception applies to payouts from the plan of the employer you left.

Flexibility varies by plan. Vanguard found 43% of plans let former employees take partial withdrawals whenever they want in 2025, up from 35% in 2020. In plans without that feature, taking any money out means withdrawing or rolling over the entire balance.

Direct rollovers and the 20% withholding rule

There are two ways to move a 401(k), and the IRS treats them very differently.

A direct rollover goes from your plan to an IRA or another employer plan without passing through your hands. No tax is withheld, per IRS Publication 575.

If the plan pays you instead, IRS rules require it to withhold 20% for federal income tax, and you can't opt out of that withholding. You then have 60 days from the day you receive the money to deposit it in an IRA or another plan. To keep the full amount tax-deferred, you have to make up the withheld 20% from other money, per IRS Tax Topic 413.

This is the trap we see most often, and it catches smart people because the form doesn't make the cost obvious. The check looks like your money; the missing 20% only shows up when you try to put it all back.

The IRS's own example uses Jordan, age 42, with a $10,000 distribution and $2,000 withheld. If she rolls over the $8,000 she received, she reports $2,000 as taxable income and owes the 10% additional tax on it unless an exception applies. If she adds $2,000 of her own money and rolls over $10,000, she reports the full amount as a nontaxable rollover and gets the $2,000 withheld back as a tax credit when she files.

Line	Rolls over $8,000	Rolls over the full $10,000
Distribution	$10,000	$10,000
Withheld by the plan	$2,000	$2,000
Check received	$8,000	$8,000
Added from other savings	$0	$2,000
Reported as nontaxable rollover	$8,000	$10,000
Reported as taxable income	$2,000	$0
Reported as taxes paid	$2,000	$2,000
10% additional tax applies to	$2,000, unless an exception applies	$0

Note: Row values are the IRS example's figures. The $2,000 withheld is credited as tax paid when you file.

Exhibit 2. Source: Internal Revenue Service, Rollovers of retirement plan and IRA distributions (example of Jordan, age 42)

A rollover into a new employer's plan works the same way, if that plan accepts rollovers. Vanguard reports 7% of its plans had adopted automatic portability by the end of 2025, which moves small balances to a new employer's plan for you.

The IRS's limit of one IRA-to-IRA rollover in any 12-month period doesn't apply to rollovers from a 401(k) or to direct trustee-to-trustee transfers, per its rollover guidance.

Rollovers have become more common. In 2025, 25% of Vanguard participants leaving an employer rolled their savings over, the highest share in ten years, while the 28% who took cash was the lowest in that span.

Remain in planRolloverCash lump sum

Note: Installment payments and the rollover-and-cash combination (1% or less each year) are not shown.

Exhibit 3. Source: Vanguard, How America Saves 2026, Figure 116, Trends in distribution of plan assets (participants with termination dates in the given year)

The age-55 exception to the 10% early-withdrawal tax

Withdrawals from a 401(k) before age 59 1/2 generally carry a 10% additional tax on top of regular income tax, per IRS Tax Topic 558.

The age-55 exception is narrower than its nickname suggests. IRS Publication 575 says the 10% additional tax doesn't apply to distributions from a qualified retirement plan after you separate from service in or after the year you reach age 55. For qualified public safety employees in governmental plans, the age is 50, or 25 years of service if that comes first.

People in their mid-50s tend to hear about this rule from a friend, and the version they hear is usually missing a detail. We ask clients to check the year they turn 55 against the date on their separation letter before anything else.

Three details decide whether it applies:

• The year of separation counts. Someone who leaves in March of the year they turn 55 qualifies. Publication 575's example is George, who left at 49 and took a distribution at 55; he didn't qualify, because he separated before the year he reached 55.
• It applies to the plan of the employer you left. Tax Topic 558 says these exceptions apply to distributions from a qualified plan other than an IRA, so money rolled into an IRA loses this exception.
• It removes the 10% additional tax only. The withdrawal is still taxable income, and a lump sum paid to you still has 20% withheld.

So for someone laid off at 56, the order of steps changes the tax result. Money left in the former employer's plan can be withdrawn without the 10% additional tax, while the same dollars rolled into an IRA would face it until 59 1/2 unless another exception applies.

Cash-outs and outstanding 401(k) loans

A cash-out is ordinary income for the year it's paid. It also counts toward the income estimate HealthCare.gov uses for marketplace premium tax credits, which tells applicants to include most IRA and 401(k) withdrawals. A withdrawal taken in the same year as a full salary and a severance payment is added on top of both.

If you're weighing a withdrawal to cover the gap until the next job, that's a reasonable thing to think about, and plenty of people do. It goes better when the tax bill and the health insurance effect are on the same page as the cash you'd receive.

The Vanguard data show who cashes out. By age, the share of departing participants taking cash in 2025 ranged from 22% of those in their 60s to 32% of those in their 40s. In dollars, cash-outs were 5% of assets for people in their 50s and 2% for people in their 60s.

Participants taking a cash lump sumAssets taken as a cash lump sum

Note: Vanguard recordkeeping data, not a national sample. Not shown: the rollover-and-cash combination (1% or less) and installment payments (10% of participants in their 70s, 1% or less at other ages).

Exhibit 4. Source: Vanguard, How America Saves 2026, Figure 117, Plan distribution behavior by age, 2025 (participants with termination dates in 2025)

Balance size tracks the decision closely. Vanguard found 59% of participants with $5,000 to $9,999 kept their savings in a plan or IRA, against 89% of those with $100,000 to $249,999 and 95% of those with $500,000 or more.

Note: Preserving means staying in the former employer's plan or rolling over to an IRA or another plan. Category bands abbreviate Vanguard's ranges ($1,000 to $4,999 and so on).

Exhibit 5. Source: Vanguard, How America Saves 2026, Figure 118, Plan distribution behavior by account balance, 2025

Outstanding 401(k) loans follow their own rule. When you leave, the plan typically reduces your balance by the unpaid loan, which the IRS calls a plan loan offset. An unpaid loan is treated as a taxable distribution. When the offset happens because of severance from employment, Publication 575 says you have until your tax return due date for that year, including extensions, to roll over the offset amount, using other money to make up the loan. That's longer than the usual 60-day window.

The IRS caps 401(k) loans at the lesser of $50,000 or the greater of $10,000 or 50% of your vested balance, so an offset can be large.

401(k) distribution election screen

Screen title

Request a distribution

Plan

Acme Manufacturing 401(k) Savings Plan

Employment status

Separated from service: September 30, 2026

Vested balance

$412,000.00

Outstanding loan

$18,500.00 (will be offset against your balance)

Option 1

Leave my balance in the plan

1Option 2

Direct rollover to an IRA or another employer plan. No federal tax withheld.

2Option 3

Pay to me. 20% federal income tax will be withheld. You may roll over within 60 days.

Option 4

Partial payment to me, remainder stays in plan (if your plan allows)

Notice link

Special Tax Notice Regarding Plan Payments (402(f) notice)

3Age note

You separated in or after the year you turned 55. Payments from this plan may not be subject to the 10% additional tax.

4Loan note

You can roll over the offset loan amount until your federal tax return due date, including extensions, for 2026.

1. 1A direct rollover moves the money plan to plan with no federal tax withheld.
2. 220% is withheld and you can't opt out. To roll over the full balance within 60 days, you replace that 20% from other savings.
3. 3The age-55 exception covers payouts from this plan only. Money rolled into an IRA loses it until 59 1/2.
4. 4The unpaid loan is subtracted from the balance and taxed unless you roll over the same amount by your tax filing deadline, including extensions.

The screen in the mock uses example values. Your plan's distribution request page and its 402(f) tax notice list the options your plan actually offers, and those are the ones you can choose from.

Working with FirstSourceTeam

FirstSourceTeam is a family-owned firm in Minneapolis, and we've coached job seekers since 2006. When the 401(k) question comes up, we help you think it through: what your plan allows, which dates apply, and how a withdrawal would interact with severance, taxes and health coverage. We don't recommend an account, an investment or a tax move; for that, a tax professional or financial adviser reviews your situation. Most of our work is the job search itself: one-to-one coaching, a rebuilt resume and LinkedIn profile, interview preparation and introductions to recruiters. The easiest first step is our free one-hour webinar, every Wednesday at 11 AM Central with John Schrup and Misty Schnuelle.

Sources

1. Internal Revenue Service, Topic no. 413, Rollovers from retirement plans, accessed Oct 12, 2026.
2. Internal Revenue Service, Topic no. 558, Additional tax on early distributions from retirement plans other than IRAs, accessed Oct 12, 2026.
3. Internal Revenue Service, Publication 575 (2025), Pension and Annuity Income, accessed Oct 12, 2026.
4. Internal Revenue Service, Publication 560 (2025), Retirement Plans for Small Business, accessed Oct 12, 2026.
5. Vanguard, How America Saves 2026, accessed Oct 12, 2026.
6. Internal Revenue Service, Rollovers of retirement plan and IRA distributions, accessed Oct 12, 2026.
7. Internal Revenue Service, Retirement plans FAQs regarding loans, accessed Oct 12, 2026.
8. HealthCare.gov, What income to include in your estimate, accessed Oct 12, 2026.