My Company May Be Folding. Should I Cash Out My 401(k)?

Certain signs may indicate that your company is on the verge of going under. For one thing, you can surmise that things are amiss if your employer implements pay cuts or starts laying off staff members at a rapid pace. Similarly, if your company won't approve new projects or initiatives, it may be a sign of serious financial problems at hand -- problems significant enough to cause your company to fold.

That's not a great situation to be in, as it could leave you out of a job. So if you have reason to believe that your company may be folding, it's a good idea to dust off your resume and start reaching out to professional contacts for job-related leads. 

It's also a good idea to move your money out of your 401(k) plan in that situation. If your company goes under, you might have to do that at some point. But it's a good idea to be proactive, especially if you plan to look for a new job.

But while it's smart to find a new home for your retirement savings in this scenario, cashing out your 401(k) is a different story. That's a move you might sorely regret.

Don't be so quick to cash out your 401(k)

There are a couple of problems with cashing out a 401(k) -- whether because you're leaving your job or because your company is dissolving and won't be around much longer. For one thing, if you have money in a traditional 401(k), as opposed to a Roth, any distribution you take will be subject to being taxed. This is the case no matter how old you are when you take a withdrawal from a 401(k).

But here's where age does come into play. If you take a 401(k) plan distribution prior to reaching 59 1/2, you'll be hit with a 10% early withdrawal penalty. So if you have a $25,000 balance and you cash out your 401(k) at age 42, you'll lose $2,500 right off the bat. When you've worked hard to save up money for retirement, you don't want to lose a big chunk of it to penalties.

A better option for your 401(k)

If you think your company is folding and you plan to look for a new job but don't have one yet, then your best bet is generally to roll your 401(k) into an IRA. IRAs are not tied to employers. Rather, you're in charge of managing your account. You can open an IRA at any financial institution that offers one. 

You should know that the IRS limits the amount of money you can contribute to an IRA each year. In 2023, for example, contributions are capped at $6,500 for savers under age 50 and $7,500 for those 50 and older.

But these limits apply to contributions you make out of your earnings. They don't apply to 401(k) rollovers. You're allowed to roll your entire 401(k) balance into an IRA if you're closing out that account and need a new home for your retirement savings.

It's unfortunate when a company folds, as it could mean the loss of many jobs. That's a hard enough blow as it is. So don't make things harder by leaving your 401(k) in limbo or, worse yet, cashing it out early and paying a penalty for doing so. Instead, open an IRA and roll your savings into that account directly so there's one less thing to worry about as you seek out new employment opportunities.