How to Avoid Being Forced Out of Your 401(k)
When you change jobs, it's important to pay attention to what will happen to the money in your 401(k). If you want to avoid paying taxes and penalties, you can typically leave the money in the 401(k) plan, roll it over to an individual retirement account or transfer the money to your new employer's 401(k) plan if they allow it. But if you don't choose one of those options, your former employer might select one for you, especially if you have a small balance.
If you have less than $5,000 in a 401(k) plan when you change jobs and don't indicate what should be done with the money, the plan can transfer the account balance to an IRA of the plan's choosing. And if you have under $1,000 in the account, the plan is allowed to send you a check, which could trigger taxes and penalties if you don't put it into another retirement account in a timely manner. Over half (57 percent) of 401(k) plans transfer balances between $1,000 and $5,000 to an IRA when the participant leaves the employer and cash out balances of less than $1,000, according to a Plan Sponsor Council of America survey of 613 plans with 8 million participants.
These transfers of cash from 401(k)s to IRAs don't usually trigger income tax or the early withdrawal penalty, but they often subject savers to high fees and low investment returns in the new account. A recent Government Accountability Office analysis of ten providers of forced-transfer IRAs found that fees outpaced returns in most of the IRAs that were automatically set up for workers who changed jobs, and these account balances tended to decline over time. "Most forced-transfer IRA balances in accounts we analyzed will decrease if not transferred out of forced-transfer IRAs and reinvested, because the fees charged to the forced-transfer IRAs often outpace the low returns earned by the conservative investments prescribed by the Department of Labor's safe harbor regulations," according to the GAO report.
The typical investment return for the forced-transfer IRAs ranged from 0.01 percent to 2.05 percent, while administrative fees run from $0 to $100 or more to open the account and $0 to $115 annually, which would steadily decrease a small balance with no new contributions, GAO found. When GAO projected the effects on a $1,000 balance over time, they found that 13 of the 19 balances examined decreased to $0 within 30 years and one declined to $0 within nine years. "Even if an account holder claimed their forced-transfer IRA after a few years the balance would have significantly decreased," according to the GAO report. The average decline in a $1,000 account balance was about 25 percent over 5 years.
The default investments for forced-transfer IRAs are often conservative, such as money market funds, and tend to produce lower returns than the most common default investment for 401(k) plans, target-date funds. GAO calculated that a $1,000 forced-transfer IRA balance invested in a target-date fund could grow to about $2,700 over 30 years, while the balance would decline to $0 if invested in a money market account, assuming a 1.45 percent return on the money market fund, a 6.3 percent return on the target-date fund and the same account fees in both cases.
Individuals who are automatically enrolled in 401(k) plans and who change jobs frequently could end up with multiple forced-transfer IRAs that incur duplicative fees. "Low-wage workers and young workers are vulnerable to forced transfers since they may change jobs often, which can leave them with particularly low balances," GAO found.
Here's how to protect yourself from being forced out of your 401(k) plan and losing your savings as a result:
Update the contact information on your 401(k) plan. If you used a company e-mail account to register your 401(k) plan or you move to a new residence after you leave a job, the 401(k) administrator at your former employer may have difficulty contacting you about the 401(k) plan, resulting in your money being transferred to an IRA without your knowledge. When you open a 401(k) plan, use an e-mail address that isn't tied to your job to make staying in touch easier if you ever change jobs. Also, remember to update the address on the account each time you move.
Provide clear instructions. A 401(k) plan can only shift money into a forced-transfer IRA in the absence of participant instructions. If you don't like the forced-transfer IRA or would prefer that your money be deposited elsewhere, a phone or Internet transfer should correct the problem. You could, for example, set up an IRA with fees and investments you are comfortable with and roll over your 401(k) balance to it each time you change jobs.
Pay attention to former 401(k) plans. There are instances when it makes sense to leave your money in a former employer's 401(k) plan, such as when it has particularly good investment options or very low costs. But if your balance is small, you could be forced out at a later date. While some employers force out participants with small balances immediately upon their separation from service, other employers sweep out former employees with small balances once a year or when they amend the rules of the plan.
Track down lost 401(k) accounts. Consolidating all your 401(k) accounts from previous jobs into a single 401(k) or IRA can simplify your life. But if it's been a while, it can sometimes be difficult to track down former accounts. The first step is to try to get in touch with your former employer. You can also request a Potential Private Pension Benefit Information notice from the Social Security Administration to see if they have any information on file about your former 401(k) plan. The SSA says that between 2004 and 2013 workers left more than 16 million accounts containing $5,000 or less in the plans of former employers cumulatively totaling $8.5 billion.
Build up a larger balance. You will earn more protections once you accumulate a moderate balance in your 401(k) plan. Active 401(k) plans are prohibited from distributing the money of people with more than $5,000 in the account without the consent of the participant.
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