To close a 401(k) account, you file a distribution election with your plan administrator instructing them to pay out your entire vested balance — either as a direct rollover into another retirement account, an indirect rollover you complete yourself within 60 days, or a full cash distribution. The tax consequences turn on which of those three you pick, your age at the time, and whether you have an outstanding loan against the plan. Most people close a 401(k) after leaving the employer that sponsored it.
When You Can Close the Account
Most plans do not permit a full distribution while you still work for the sponsoring employer. The usual trigger is separation from service — quitting, being laid off, or retiring. Some plans allow in-service withdrawals once you reach age 59½, but that is a plan-by-plan feature rather than a federal right.
Before assuming your entire balance is available, check your vesting. Your own salary deferrals are always 100 percent vested and belong to you regardless of when you leave. Employer contributions, including matching funds, follow a separate vesting schedule set by the plan, which may vest immediately or increase your ownership percentage each year of service. Any unvested employer money is forfeited when you leave.1Internal Revenue Service. Retirement Topics – Vesting
The Three Ways to Take the Money Out
Closing the account means the balance has to go somewhere. Your three choices carry very different tax outcomes.
Direct Rollover
A direct rollover moves funds straight from your old 401(k) into another eligible retirement account — either a new employer’s plan or an IRA. The money never passes through your hands, so no 20 percent federal withholding applies.2Office of the Law Revision Counsel. 26 USC 3405 – Special Rules for Pensions, Annuities, and Certain Other Deferred Income If the administrator issues a check, it should be made payable to the receiving institution “for the benefit of” you rather than to you personally; that form of check still counts as a direct rollover and is not subject to withholding.3Internal Revenue Service. Rollovers of Retirement Plan and IRA Distributions
Indirect Rollover
In an indirect rollover, the plan pays the distribution to you, and you have 60 days to redeposit the full amount into another eligible retirement account. The complication: the plan withholds 20 percent for federal taxes before cutting your check. To roll over the entire distribution and avoid tax on the withheld portion, you have to supply that 20 percent from other funds and deposit it along with the check into the new account inside the 60-day window.3Internal Revenue Service. Rollovers of Retirement Plan and IRA Distributions
Miss the deadline and the whole distribution becomes taxable income for that year, plus the 10 percent penalty if you are under 59½.
Full Cash Distribution
A cash distribution deposits the balance in your personal bank account. The administrator withholds 20 percent for federal income tax at payment, and the entire distribution is ordinary income on that year’s return.4eCFR. 26 CFR 31.3405(c)-1 – Withholding on Eligible Rollover Distributions Your state may also impose its own withholding, depending on where you live.
What You Need to Submit the Request
Have these items ready before you contact the plan administrator:
- Your Social Security number and plan account number.
- The sponsoring employer’s name.
- Contact information for the plan custodian (Fidelity, Vanguard, Schwab, or whoever holds the account), which appears on your most recent statement or through HR.
- The name, mailing address, and account number of the receiving IRA or 401(k) if you’re rolling over.
- The plan’s Distribution Election Form, available through the custodian’s portal or from HR.
On the form, indicate that 100 percent of the balance is to be distributed. For a direct rollover, give the exact legal name and account details of the receiving institution so the check is made payable correctly.
One boundary worth checking: if you are married and the plan is subject to qualified joint and survivor annuity rules — common in defined benefit and money purchase plans, and applicable to some 401(k)s — your spouse must sign a notarized or plan-witnessed consent to any distribution form other than the joint annuity. Ask the administrator whether your plan requires it.5U.S. Department of Labor. FAQs About Retirement Plans and ERISA
The Tax Bill on a Cash-Out
Any eligible rollover distribution paid directly to you triggers a mandatory 20 percent federal income tax withholding. The plan administrator is required to hold that amount back, and you cannot opt out.2Office of the Law Revision Counsel. 26 USC 3405 – Special Rules for Pensions, Annuities, and Certain Other Deferred Income
The 20 percent is a prepayment, not a final tax rate. Your actual liability depends on your total income for the year. If withholding exceeds what you owe, the difference comes back as a refund. If your bracket puts you above the effective 20 percent, you owe more at filing.
Direct rollovers avoid this entirely because the money moves between tax-advantaged accounts without you taking possession.6Internal Revenue Service. Topic No. 413, Rollovers From Retirement Plans
If part of your balance sits in a designated Roth 401(k), it’s treated differently. Roth contributions were made with after-tax dollars, so qualified distributions — generally after age 59½ and at least five years after your first Roth contribution — come out tax-free. Rolling the Roth portion into a Roth IRA preserves that status. A non-qualified Roth distribution can subject the earnings portion to income tax and the early withdrawal penalty.
The 10 Percent Early Withdrawal Penalty
Take a cash distribution before age 59½ and the IRS adds a 10 percent additional tax on top of the regular income tax. It’s reported on Form 5329 with your return.7Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
Several exceptions apply even if you’re under 59½:
- Rule of 55: if you separate from service during or after the year you turn 55, distributions from that employer’s 401(k) are penalty-free. Public safety employees qualify at 50. It applies only to the plan of the employer you left, not to old 401(k)s or IRAs.
- Total and permanent disability.
- Death (distributions to a beneficiary).
- Substantially equal periodic payments based on life expectancy, continued for at least five years or until you reach 59½, whichever is longer.
- Unreimbursed medical expenses above 7.5 percent of adjusted gross income.
- IRS levy against the plan.
- Qualified military reservists called to active duty.
The Rule of 55 deserves a second look if you’re closing the plan between 55 and 59½. It applies to qualified plans, not IRAs. Rolling your 401(k) into an IRA before taking distributions gives up this exception. If you need the money penalty-free in that age window, pull it from the 401(k) first.
If You Have an Outstanding 401(k) Loan
An unpaid loan against the plan complicates closure. Most plans require full repayment when you leave. If you can’t repay it, the remaining balance is treated as a distribution — called a plan loan offset — and reported as taxable income.8Internal Revenue Service. Retirement Topics – Plan Loans
When the offset happens because you separated from service or the plan terminated, it qualifies as a Qualified Plan Loan Offset (QPLO). A QPLO extends the usual 60-day rollover window to your tax filing due date for that year, including extensions. Filing for a six-month extension pushes the rollover deadline with it.9Internal Revenue Service. Plan Loan Offsets
Miss that deadline and the offset amount becomes taxable income, with the 10 percent penalty on top if you’re under 59½.
Small Balances Can Be Closed Without You
If your vested balance is $7,000 or less when you leave, the plan can distribute your money without your consent. Under the SECURE 2.0 Act, which raised the threshold from $5,000, plans may automatically roll balances between $1,000 and $7,000 into an IRA on your behalf. Balances of $1,000 or less can be paid directly to you as a check.
Automatic rollover IRAs are typically invested in capital-preservation products such as money market funds. You can move the money to your own IRA or a new employer’s plan at any time. Watch the mail after you leave a job; the notice may go to your last known address, and missing it can leave your money sitting in a low-return account for years.
If Your Plan Holds Employer Stock
Net Unrealized Appreciation (NUA) is a separate tax rule that can save significant money if your 401(k) holds shares of your employer’s stock. Under NUA, you pay ordinary income tax only on the original cost basis — what the shares were worth when contributed to the plan. Growth above that basis is taxed at the long-term capital gains rate when you sell the shares, regardless of how long you hold them after distribution.10Office of the Law Revision Counsel. 26 USC 402 – Taxability of Beneficiary of Employees Trust
To qualify, you must take a lump-sum distribution of your entire balance from all of that employer’s plans of the same type in a single tax year, triggered by separation from service, reaching 59½, disability, or death. The stock goes into a taxable brokerage account, not an IRA, and only the cost basis is taxed that year. Additional gain after distribution is taxed as short- or long-term capital gain based on how long you hold the shares.
NUA works best when the stock has appreciated significantly against a low cost basis. If it hasn’t, a standard rollover to an IRA — where the whole amount continues to grow tax-deferred — usually beats it. The math and timing are complex enough to be worth running past a tax professional.
How the Distribution Is Reported
The plan administrator must send you Form 1099-R by January 31 of the year following your distribution. It shows the gross amount, the taxable portion, any federal and state tax withheld, and a distribution code in Box 7 telling the IRS what kind of distribution you took.11Internal Revenue Service. 401(k) Resource Guide – Plan Sponsors – Filing Requirements
A direct rollover still generates a 1099-R, but the taxable amount should be zero or carry a rollover code. Don’t ignore a 1099-R showing a large distribution; if the rollover code is missing or wrong, ask the administrator for a corrected form before you file.
If you took an early distribution that qualifies for a penalty exception, the 1099-R may not reflect it. File Form 5329 with your return to claim the exception and avoid being assessed the 10 percent.7Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions