Your employer shut down the 401(k): what are your options?
When your employer shuts down (terminates) its 401(k) plan, you have to move your money out, but you almost never have to pay tax to do it. For most people the best move is a direct rollover into a rollover IRA (a traditional IRA that receives plan money): no tax, no penalty, and the balance keeps growing tax-deferred. You can also roll it into a new employer's 401(k) if you have one. Cashing out is the option to avoid: the withdrawal is taxed as ordinary income and, if you are under age 59½, hit with an extra 10% penalty. One thing to know up front: the rollover itself is not a new contribution and gives you no tax deduction. To keep saving, you contribute fresh money to the IRA after the rollover, and a traditional-IRA contribution is where the tax deduction comes from.
What happens when a 401(k) plan is terminated?
When a company ends its 401(k) plan, the plan has to distribute everyone's vested balance. Your money cannot stay in a plan that no longer exists. You become 100% vested in any employer contributions on termination, and the plan sends you a notice explaining your distribution choices and a deadline to act. If you do nothing, the plan can force small balances out on your behalf, sometimes into an IRA it picks for you, so it is worth choosing on purpose rather than letting it happen to you.
The good news: a plan termination is a "distributable event," which means you are allowed to roll the money over without tax. The whole decision is really about where the money goes next, not whether you owe tax today. Pick a rollover and you owe nothing now.
Your four options
| Option | Tax now? | Best for |
|---|---|---|
| Direct rollover to a traditional (rollover) IRA | No tax, no penalty | Most people. Keeps money tax-deferred and gives you the widest investment choice. |
| Direct rollover to a new employer's 401(k) | No tax, no penalty | People starting a job with a plan that accepts rollovers, who want everything in one place. |
| 60-day (indirect) rollover | No tax if completed in time, but 20% is withheld up front | Almost nobody on purpose. The withholding makes it easy to owe tax by accident. |
| Cash out | Yes: ordinary income tax, plus 10% penalty if under 59½ | Emergencies only. You lose a chunk to tax and give up decades of tax-deferred growth. |
The default choice: a direct rollover to an IRA
A direct rollover means the plan sends your balance straight to the receiving account, either as a check made out to the new custodian "for benefit of" you, or by wire. Because the money never lands in your personal bank account, there is no tax and no withholding. The IRS describes the mechanics plainly: with a direct rollover, "the administrator will issue your distribution in the form of a check payable to your new account. No taxes will be withheld from your transfer amount."
A traditional IRA at any major brokerage is the usual destination. It takes your pre-tax 401(k) money as-is, keeps it tax-deferred, and typically gives you far more investment options than an employer plan did. This is the move I would default to for almost anyone whose plan was shut down.
The 20% withholding trap in a 60-day rollover
There is a second, worse way to roll money over, and the difference costs real money. If you take the distribution as a check payable to you and then redeposit it into an IRA within 60 days, that is a "60-day" or "indirect" rollover. The problem: when a workplace plan pays you directly, it is required to withhold 20% for federal taxes. The IRS states that on an eligible rollover distribution paid to you, "the payer must withhold 20% of it."
Here is why that bites. Say your balance is $50,000. In a 60-day rollover the plan sends you $40,000 and withholds $10,000. To complete a full tax-free rollover, you must deposit the entire $50,000 into the IRA within 60 days, which means finding that missing $10,000 from your own pocket. You get the $10,000 back later as a tax refund, but if you can only redeposit the $40,000 you actually received, the other $10,000 is treated as a taxable withdrawal, plus a 10% penalty if you are under 59½. A direct rollover skips this entire problem. There is no reason to choose the 60-day route for a simple plan-to-IRA move.
What cashing out actually costs
Cashing out feels simple, and it is the most expensive choice. The full amount is added to your income and taxed at your ordinary rate for the year. On top of that, the IRS applies a 10% additional tax on early distributions if you are under age 59½, with limited exceptions. Between federal income tax, possible state tax, and the 10% penalty, someone in a middle bracket can lose roughly a third of the balance, and that is before counting the decades of tax-deferred growth they gave up. Treat cashing out as an emergency-only option.
Can you roll it into a solo 401(k) instead?
Only if you have your own self-employment income. A solo 401(k) (also called a one-participant or individual 401(k)) is built for business owners with no full-time employees, and you can only open one if you have self-employment or business-owner earnings. Being a W-2 employee, even a well-paid one, does not qualify you. If that describes you, the rollover IRA is your path, not a solo 401(k). If you also run a side business or do 1099 work, then yes, you could open a solo 401(k) and roll the old balance into it. We walk through exactly who qualifies on can an employee open a solo 401(k)?
After the rollover, how do you keep contributing?
This is where a common mix-up shows up, so it is worth being precise. Moving your old 401(k) into an IRA is a rollover, not a contribution. It does not count against the annual IRA limit, and it gives you no tax deduction, because it is money that was already sheltered from tax simply changing accounts.
To keep adding new money, you contribute to that same IRA out of your paycheck, up to the annual limit. For 2026 that is $7,500, or $8,600 if you are 50 or older. You choose the tax treatment:
- Traditional IRA contribution: you may deduct it on your tax return, which is the "money back at tax time" effect. You put in already-taxed paycheck dollars, deduct the contribution, and get that tax back. You pay tax later when you withdraw in retirement.
- Roth IRA contribution: no deduction now, but qualified withdrawals in retirement come out completely tax-free.
So your instinct that you can "get money back on taxes" is right, it just attaches to a new traditional IRA contribution, not to the rollover and not to a solo 401(k). See Roth IRA vs traditional IRA to decide which fits you.
Is the traditional IRA contribution fully deductible?
It depends on whether you are covered by a workplace retirement plan during the year and on your income. Once your employer's plan is terminated and you are not in a new one, the deduction is usually wide open. The IRS rule: "If neither the taxpayer nor the spouse is covered by a retirement plan at work, the phase-outs of the deduction do not apply," meaning there is no income limit on the deduction at all. If you (or a spouse) are still an active participant in a workplace plan for the year, these 2026 income ranges reduce or remove the deduction:
| Your situation | 2026 phase-out range |
|---|---|
| Single or head of household, covered by a workplace plan | $81,000 to $91,000 |
| Married filing jointly, you are covered by a workplace plan | $129,000 to $149,000 |
| Married filing jointly, you are not covered but your spouse is | $242,000 to $252,000 |
| Married filing separately, covered by a workplace plan | $0 to $10,000 |
| Neither you nor your spouse covered by a workplace plan | No income limit; fully deductible |
Below the bottom of your range you get the full deduction; inside the range it shrinks; above the top you can still contribute to a traditional IRA but cannot deduct it. A Roth IRA contribution is never deductible, so these ranges do not apply to it (Roth has its own separate income limits).
What about Roth 401(k) money?
If part of your terminated 401(k) was a Roth (designated Roth) balance, roll that portion directly into a Roth IRA, not a traditional one. Roth stays with Roth so the money keeps its tax-free treatment. Any after-tax (non-Roth) contributions you made can also generally go to a Roth IRA. Your plan's distribution paperwork will break the balance into pre-tax, Roth, and after-tax buckets so you can direct each to the right account.
The bottom line
A terminated 401(k) is a "move it, do not lose it" moment. For almost everyone the answer is a direct rollover into a rollover IRA: no tax, no penalty, and your money keeps compounding. Skip the 60-day route and its 20% withholding, and treat cashing out as an emergency-only last resort. Once the money is in the IRA, keep contributing new dollars up to $7,500 for 2026 ($8,600 if 50+), and choose traditional if you want the deduction now or Roth if you want tax-free withdrawals later. This is general information, not tax advice. For your own numbers, check the IRS pages below or talk to a qualified tax professional.
Sources
- Direct rollovers issue a check to the new account with no tax withheld, the 60-day rule, and that a rollover is tax-free: IRS, Rollovers of retirement plan and IRA distributions.
- The mandatory 20% withholding on eligible rollover distributions paid to you: IRS, Rollovers of retirement plan and IRA distributions, and IRS Publication 575, Pension and Annuity Income (PDF).
- The 10% additional tax on early distributions before age 59½: IRS, Topic no. 558, Additional tax on early distributions.
- 2026 IRA contribution limit ($7,500 / $8,600) and the traditional IRA deduction phase-out ranges, plus the "no limit if neither spouse is covered" rule: IRS newsroom, 401(k) and IRA limits for 2026, and IRS, IRA deduction limits.
- Solo 401(k) requires self-employment income and no full-time employees: IRS, One-participant 401(k) plans.