Can You Still Collect Unemployment If You Cash in Your 401(k)?

Unemployment insurance is a plan run by the federal government and each state. The two entities as well as employers pay into this fund to insure workers who are laid off through no fault of their own. The amount of your benefit is based on your earnings and is not tied to savings, investments or funds you may have on hand. The amount in your 401(k) plays no role in your entitlement to unemployment, whether you cash it in or not.

Each state has different requirements for eligibility. While no states take investment value into account when figuring unemployment eligibility, you must have worked for a certain amount of time, based on your state's requirements. For example, in North Carolina, you need to have worked for at least minimum wage for 18 months or more prior to your unemployment claim. If you are fired for cause, you are not eligible for unemployment.

Additionally, you must be available to work to maintain your eligibility. However, it is worth noting, that due to the current Coronavirus (Covid-19) pandemic, at time of publication, at least 27 states are temporarily waiving the job search requirement that is generally necessary in order to collect unemployment.

When you leave a job, you have a number of options regarding how you handle your 401(k), including leaving the funds in your existing plan. The money is yours, however, and you can cash it out. Since you are no longer with your employer, the age when penalties kick in is 55, instead of the standard 59-1/2 usually required to avoid early withdrawal penalties. If you are under 55, however, you will have to pay the 10 percent penalty on the funds, in addition to the income tax that was deferred when the money was invested.

But, with the recent passage of the Coronavirus Aid, Relief and Economic Security Act, or CARES Act, those adversely affected by COVID-19 can avoid this early withdrawal penalty for 2020 distributions. Additionally, when you cash out, your employer is required to hold back 20 percent to pay those taxes, leaving you with less than you may have expected. However, due to the CARES Act, there is also no longer a mandatory withholding requirement of 20 percent. Your distribution can now be evenly spread out and taxed as income until the 2022 tax year.

Some companies send you the balance of your retirement account if it's below a certain amount. If you don't roll it over into another eligible retirement fund, you could incur penalties if you under 55 and no longer with that company. The most effective way to maintain your retirement fund and avoid penalties and taxes is to roll the 401(k) into an eligible account, such as an individual retirement account.

The entire amount can be moved from your 401(k) into a traditional IRA with no penalties or tax consequences. This allows you to protect your retirement funds while you search for another job.

Once you've transferred your money into an IRA, it is easier to liquidate the funds as you need them. Additionally, you can take money out of an IRA without any early withdrawal penalties for specified reasons, some of which may become pertinent while you're unemployed. You can take funds out of an IRA to pay for medical insurance premiums or outstanding medical bills. IRA funds can be used, penalty-free, to pay for school. You also can use the money as a down payment on a house if you're a first-time buyer. You are still responsible for income taxes, however.