As our economy begins to recover, more and more workers will be seeking new jobs. In fact, a recent survey has noted that two out of three employees want to find a new position. So what happens to their 401(k)s when they leave?
For many people, nothing, according to Fidelity Investments. In a recent study, the company found more than 70 percent of the job hoppers left their retirement investments with their former employer’s plan. Of those staying with their old plan, nearly 60 percent were satisfied with their plan’s features, while 27 percent said they just didn’t have the time or interest in taking action. Only 18 percent of the job changers planned to move the money to an IRA or their current employer’s plan. Nearly a quarter of those surveyed were not sure what they were going to do.
It appears that the same inertia many employers encounter in encouraging employees to join a 401(k) applies to moving their retirement accounts when they leave for another position. All those inactive participants can be a drain on the administration of your pension plan – and if you have enough inactive accounts, they can even cause your small retirement plan to become large enough to require an ERISA audit.
When former employees become inactive participants in your pension plan, it becomes easy to lose track of them and more difficult to communicate with them. Former employees are not readily available for staff meetings, accessing your company’s intranet or receiving staff emails. If they move from the last known address on your records, you may be unable to reach them to communicate plan changes or investment options, which could lead to 404(c) compliance issues.
And even though keeping inactive accounts can make an administrative nightmare for you, it’s also important to note that shedding small and inactive participant balances might not be something your financial advisor would encourage. We’re not speaking ill of financial advisors, it’s just that they are compensated based on a percentage of the plan assets. Financially, they don’t have an incentive to encourage your company to shed inactive participants or remind you to review them.
Two best practices you can follow as your retirement plan’s fiduciary are to aggressively encourage departing employees to rollover their 401(k) balances and make the rollover process as easy to do as possible.
Provide rollover options to departing employees during the separation process. Clearly communicate the participant’s options, and organize the paperwork to make it easy for the separating employee to return it.
Employers can set up an automatic IRA rollover for departing employees. With an automatic rollover option, at the time of separation from employment, plan participants receive a written notice informing them that their plan will be automatically rolled over into an IRA at a specific location unless they initiate the rollover process to a plan of their choice by a deadline.
Keeping the 401(k)
If separating employees decide to keep the balance in their existing 401(k), they’ll need to ensure that they have the minimum amount required. However, it’s important to remind departing employees that they will no longer be able to make contributions to it, because they’ll no longer be on the payroll. Job changers are also responsible for keeping tabs on this account, should it change record keepers or move.
Rolling to a New 401(k)
If a departing employee takes their old 401(k) balance and moves it to a 401(k) at his or her new job, there will be no taxes or penalties. Best of all, they keep all of their retirement money and can now add to it at their new job. However, they’ll want to ask the new employer if there is a waiting period before they can participate in the new employer’s plan. If so, they’ll want to let their money sit in the old plan or roll it into an IRA.
Rolling Over to an IRA
If a job-changing employee transfers money from his or her old 401(k) into an IRA, the transfer will occur without incurring taxes or penalties, and they’ll also be able to contribute to the IRA at their discretion. The departing employee will also have more investment choices available and fewer restrictions than with their 401(k) plan. He or she can also roll the 401(k) money into a Roth IRA, but will need to pay taxes on the money unless it is being rolled over after-tax earnings. A financial advisor can help them through this process.
Cashing It In
This option has the most serious ramifications for job hoppers. They can take their 401(k) and cash it in, but if they take a full payout, they’ll have to pay taxes of 20 percent on it, plus incur a 10 percent penalty if they are below age 59 and a half. If they don’t have another retirement plan, they now have no retirement money – which means they’ll have to start again from the beginning and they’ll be behind in saving.
If a former employee does take a full payout but later decides they shouldn’t have, the IRS allows 60 day from the time funds are withdrawn from a 401(k) to roll it over into an IRA. The individual would still pay taxes at the time he or she takes the money out of the 401(k), so they’ll be responsible for finding the cash to bring the contribution to their IRA up to the level of their 401(k) withdrawal. However, when they file their federal tax return, they’ll get a credit for the taxes on the 401(k) and for the 10 percent penalty.
Aggressively follow up on inactive participants on a yearly basis. Often when an employee leaves your business for another position, it is a chaotic time when details – and paperwork – can be lost or forgotten. If you follow up by providing the same rollover paperwork to the former employee a year later, he or she may be in a better position to make the transition. For example, he or she may be eligible for the new employer’s 401(k) plan or better prepared to establish an IRA with a financial advisor.
Make time to review your company’s inactive 401(k) participants on a yearly basis and contact those with smaller balances. This can be an especially important practice for employers involved in a merger or acquisition, as well as those in industries that experience frequent turnover (such as retail or fast food industries) or that experienced a larger than normal number of layoffs due to the recession.
By closely managing your company’s inactive 401(k) participants, you’ll spend less time on administration to participants that aren’t there, lower per-participant fees and maintain a greater level of compliance with plan communication regulations.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.