Changing jobs? Watch out for a forced rollover of your 401(k)

If you leave a 401 (k) at your old firm, it may transfer the funds into an IRA

Published: March 26, 2015 02:00 PM

Illustration: Leo Acadia

Amid the stress of switching jobs, people often forget to shift the money in their old 401(k) to their new employer. While you won’t lose your savings but you could pay a hefty penalty for your neglect.

The tax code specifies that when a participant has less than $5,000 in a 401(k) and changes jobs without indicating what should be done with the money, the plan can transfer the savings into an individual retirement account (IRA). These forced rollovers—also known as forced transfers—are almost always a financial disaster for the account holder, according to a report from the Government Accountability Office.

To learn more about 401(k)s, visit our Retirement Planning Guide.

Under Department of Labor regulations, the transfers must be invested conservatively, such as in money market funds or certificates of deposit. The problem is that low risk equals low returns – and after fees are deducted, those returns frequently turn negative. In fact, the GAO found that that fees outpaced returns in most of the IRAs analyzed.  For example, the GAO calculates, $1,000 left in a forced-transfer IRA, after a $50 set-up fee, a $50 annual fee and a $65 annual search fee, assuming a 0.11% rate of return, would erode to zero in nine years.

Furthermore, the GAO also found that a provision in the law allows a plan to disregard previous rollovers when determining if a balance is small enough to force out. For example, a plan can force out a participant with a balance of $20,000 if less than $5,000 is attributable to contributions from savings, rather than contributions from previous rollovers.

It’s understandable that some 401(k) participants find it difficult to keep track of their savings when they change jobs. You may have accrued multiple accounts over the course of your career and not been able to consolidate your accounts by rolling over savings from one employer’s plan to the next. Second, maintaining communication with a former employer’s plan can be challenging if companies are restructured and plans are terminated or merged and renamed. And when key information on these orphaned accounts are held by different plans, service providers or government agencies, participants may not know where to go for assistance. The GAO report states, “Although the Social Security Administration provides information on benefits from former employers’ plans, the information is not provided in a consolidated or timely manner that would be useful to recipients.”

The lesson: Don’t leave small balances behind. And if you have experienced a forced transfer, quickly initiate another rollover into an IRA of your choice.

—Catherine Fredman


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