What happens to your employer-based 401(k) account when you leave a job? That's for you to decide – and if you make no decision, you may end up losing hard-earned benefits.
A recent study by the Government Accountability Office (GAO) found that over the ten-year period from the beginning of 2004 through 2013, more than 25 million Americans left their 401(k) account with a former employer. It's perfectly acceptable to keep your 401(k) in place if you can, but proper communication is key.
If your former employer is sold, restructured, or goes out of business, you have lost a valuable link to the employer's plan and may not be aware of the status of your funds. Conversely, if you fail to update the plan administrator of your new address and contact information, they may not be able to notify you when your benefits are due to be paid out.
Plan administrators may allow you to keep the 401(k) in place if you have over $5,000 in the account. With a balance below $1,000, the plan may force you out by sending you a check for the amount. With a balance from $1,000 to $5,000, the company is obligated to help you set up an IRA to receive the funds.
If you leave the decision to your ex-employer, several bad outcomes are possible.
Plan administrators may leave your account in place and notify the IRS of the plan, who in turn notifies the Social Security Administration (SSA). When you file for Social Security benefits, the SSA will send you a Notice of Potential Private Pension Information. This allows you to reclaim the lost funds – assuming you can locate them.
If the plan administrator doesn't notify the IRS about the distribution, you could receive a notice at retirement regarding benefits that were already paid out – resulting in tax confusion and forcing all parties to waste time searching for non-existent benefits.
If they cash you out, plan administrators could remove the 20% withholding for income tax and send a check to the wrong address. It goes uncashed, but the transaction is reported to the IRS – sticking you with an increased tax bill in addition to the lost funds.
The GAO report also highlights how complicated retirement issues become when a foreign workplace retirement plan is involved. Reporting requirements are not straightforward, driving up tax preparation costs for participants and increasing the risk of miscommunication.
The best way to avoid leaving your 401(k) behind is to move it somewhere as soon as possible. You have three alternatives to leaving the plan in place – roll it over to a new employer's retirement plan if that plan allows rollovers, roll it over into a separate IRA to avoid paying taxes on the distribution, or simply cash out and take the corresponding tax hit.
Generally, you have 60 days to complete a rollover into a new account to avoid taxes and potential penalties if you are under age 59-1/2. Beyond that point, you will have to use a trustee transfer to move the funds from one account to another without tax ramifications. It's best to use a direct transfer within the 60-day period, making sure that old plan funds are distributed directly to the new plan and not to you.
If you choose to cash out, consider putting those funds into a Roth IRA. You've already paid taxes on the money, so why not put it in a vehicle that gives you greater flexibility at retirement?
In short, we recommend moving your funds to a different account within a 60-day window to avoid the account being lost to you over time. If you do intend to keep it in place, you must be extremely diligent in keeping track of your old plan. Whatever you decide, make your plans known to all parties.
Regardless of where you plan to retire, the number one factor in ensuring that you can retire on your terms is your 401(k). Make sure that your 401(k) is maximizing its potential with this free analysis that checks your fees, fund mix, and other factors to help you hit your retirement goals.