In 2021, an astonishing 47.8 million people left their jobs, marking the start of what experts call “The Great Resignation.” The trend continued into 2022, with millions of Americans leaving their jobs every month. This workforce exodus had a number of triggers. Some found greener pastures in better jobs. Some retired early. Some became caregivers at home as the COVID-19 pandemic forced children and grandchildren to homeschool.
Whatever the reason, a career change can have a big impact on your taxes. If you find yourself among the millions who’ve switched jobs or left the workforce — even if you’re even merely thinking about a move —it’s wise to get familiar with these five tax considerations.
If you’ve moved to a better paying job, your new salary may bump you into a higher tax bracket. You’ll need to fill out a new W-4 and you may want to withhold more to avoid being hit with a higher tax bill. You might also consider what you can do to temper higher taxes, such as saving more in tax-advantaged savings accounts, including 401(k)s, IRAs, or health savings accounts.
What to Do With Your 401(k)
It might be tempting to cash out your 401(k) when you leave a job, but that can trigger taxes and penalties if you’re younger than 59 and a half. This should only be done as a last resort, for and emergency medical need, for example.
If you have at least $5,000 in your 401(k), you can leave your account with your old employer where your savings will continue to grow. However, you will no longer be able to contribute to the account. This option may not be ideal, as it’s possible to forget about your account. It can also prove difficult to learn about changes to the plan if you no longer work for the employer who holds it.
Another option is to roll over your 401(k) into your new employer’s plan or into an IRA. Not all employers will accept a rollover from a previous job, so check with your new employer before deciding what to do. Additionally, some employers also require you to put in a certain number of days on the job before you’re eligible to participate in a retirement savings plan, which could delay rollover plans.
If you decide to roll over your account, you can have the administrator of the last plan conduct a direct transfer by depositing your funds straight into the new plan you select. Alternatively, you can choose to receive the balance of your old account as a check. In this case, you must deposit the check into your new 401(k) within 60 days to avoid paying income tax and a 10 percent early withdrawal penalty.
Additional Tax Forms
If you’ve changed jobs, be on the lookout for multiple W-2s and other tax forms as you gear up to file your taxes. Employers are required to send W-2s before the end of January, so you should receive the final W-2 from your old employer by January 31 of the year following your job change. You may also receive other important tax forms, like a 1099-G if you received unemployment compensation or a 1099-R if you cashed out or rolled over your retirement account.
Even if you leave your job voluntarily, you may be entitled to a severance package. In some cases, you’ll also receive a payout of accrued vacation time. Both severance and paid out vacation time are treated like income and subject to the same taxes as regular wages.
Taxes and Penalties for Early Withdrawals From Retirement Accounts
If you’ve decided to retire early, understand that early withdrawals from retirement accounts may trigger taxes and penalties. As mentioned above, those younger than 59 and a half may have to pay a 10 percent penalty on any withdrawals in addition to income tax. There are certain situations, however, wherein you can make early withdrawals without penalty. Consider the rule of 55. This is an IRS provision that allows you to access funds in your 401(k) if you leave your job at age 55 or older. To qualify, you must leave your job in the calendar year you turn 55, or later. If you left your job before age 55, you will not be able to take distributions early without paying penalties.
Keep in mind that even if you are able to avoid early withdrawal penalties, you will have to pay income tax on any distributions from a 401(k) or traditional IRA. Only withdrawals from Roth accounts are tax free.
The COVID-19 pandemic changed many aspects of American work life and no doubt has contributed to seismic shifts in the workforce. If you’ve changed careers for any reason, you may need to take some additional steps to avoid a bigger-than-usual tax bill.
A version of this article appeared in our partner magazine The Essential Tax Guide: 2023 Edition.