If you change jobs and leave a balance of $5,000 or less in your old 401(k), IRS regulations permit your former employer to distribute all of those funds to you in what’s known as a 401(k) force-out.
This move could potentially lower your former employer’s plan costs and lessen their administrative duties — but it also can affect your retirement planning. Here’s what you should know about the 401(k) force-out process.
What Is a 401(k) Force-out?
As noted above, a 401(k) plan is a type of qualified retirement plan offered by employers to help employees save money and build wealth. Once an employee moves to a new job, their former employer can impose a 401(k) force-out — a distribution from the retirement plan that the IRS allows when an ex-employee’s plan balance is $5,000 or less.
The distribution does not require the ex-employee’s consent.
That doesn’t mean your former employer can do whatever they like with your 401(k) money. The IRS requires employers to observe certain 401(k) force-out rules. The rules specify:
• When an employer must notify you about your 401(k) forced distribution
• What happens to the money in your account if you’re forced out
Not every former employee is subject to a 401(k) force-out. If your 401(k) balance is greater than $5,000, your former employer can’t force you out unless you give consent. Your spouse may also need to consent.
The 401(k) Force-out Process
How 401(k) force-outs are handled can depend on the employer and the terms of your plan. It’s important to note that your plan documents must include a provision for force-outs; your former employer can’t just impose the policy on a whim.
When force-outs take place, they generally begin with an employer’s review of their 401(k) retirement plan’s account balances, including those of ex-employees. Again, if you are an ex-employee with a balance over $5,000, the IRS requires your consent before your ex-employer can do anything with the money in your account.
If the vested balance is between $1,000 and $5,000, the former employer can:
• Cut you a check for the amount
• Give you the option to roll the money over to an eligible retirement plan
• Transfer the money to an individual retirement account (IRA) on your behalf
When the balance is below $1,000 the employer can send you a check or transfer the money to an IRA.
Before the employer can do any of those things, however, they’re required to give you at least 30 days’ notice so you can decide for yourself what happens to the money. Whatever resolution you choose, you’ll no longer be investing in the 401(k) at your old employer.
Recommended: How to Open Your First IRA
Why Do Force-outs Happen?
Why do employers force 401(k) distributions on former employees? Cost is one reason. A plan with fewer enrolled employees can be less expensive to administer. Removing inactive participants can also streamline recordkeeping and potentially reduce the plan’s regulatory compliance obligations.
What Happens to a 401(k) After You Leave Your Job?
When you leave a job your 401(k) doesn’t follow you. The money stays where it is. You can’t make new contributions, but your balance may continue to grow if your investments appreciate in value.
Generally, when you leave a job, there are four things you can do with your account:
• Roll the money from your former employer’s 401(k) into your new employer’s retirement plan
• Rollover your 401(k) money into an IRA
• Leave it where it is
• Withdraw it
Keep in mind that a 401(k) cash distribution is subject to ordinary income tax — including in the case of a force-out, where it’s required by your ex-employer. You may also face a 10% early withdrawal penalty if you’re younger than age 59 ½.
Ways to Cope With a 401(k) Force-Out
What can you do to prevent the additional tax and potential penalty? Rolling over a 401(k) to your new employer’s retirement plan or to an IRA within 60 days can prevent you from owing taxes on the amount (or the 10% penalty).
A rollover may also allow you to preserve some tax benefits. For example, if you’re rolling money from one 401(k) to another or to a traditional IRA, it can continue to grow on a tax-deferred basis until you’re ready to retire. And you can keep saving for retirement in your new employer’s plan if one is offered.
Leaving the money in your former employer’s plan could make sense if you’re comfortable with the investment options offered and the fees you’re paying. Of course, that may not be possible if that employer has 401(k) force-out rules that require you to either cash out or move the money elsewhere.
Withdrawing money from a 401(k) when you leave a job is usually the least preferable option for people below the age of 59 ½. Barring exceptions, any 401(k) cash distribution before you reach that age is treated as taxable income. The IRS can also assess an early withdrawal penalty.
Keep in mind that if you’ve taken out a loan against that 401(k) account, you’ll need to pay the loan’s full outstanding balance at the time of separation. Otherwise, the IRS views the entire loan as a taxable distribution.
Can a Company Refuse to Give You Your 401(k) Money?
A company can’t refuse to give you your 401(k) funds, but there may be restrictions on when you can access those funds. If you’ve borrowed from your 401(k), for instance, an employer may require you to repay the rest of the loan before permitting you to roll over or withdraw your balance.
Starting a New 401(k)
Having left an old employer behind, you may find that starting a new 401(k) account can be as simple as opting into automatic enrollment in your new company’s plan. You may need to work a certain number of months before you’re eligible for automatic enrollment; that will depend on the plan rules.
Regardless, contributing to a 401(k) is one way to ensure that you’re on track for retirement.
For the new 401(k) plan, it’s important to consider the amount you’re deferring into the account and the fees you’ll be paying. It’s a good idea to at least contribute enough to get the full employer match (if one is offered).
You can also ask your plan administrator about scheduling annual contribution increases to coincide with yearly raises you might receive (some companies offer this as an automatic feature). Making regular adjustments to contributions and asset allocation can help you make the most of every dollar when saving for retirement.
The Takeaway
If you participated in the 401(k) plan at a past job and left less than $5,000 in the account, your former employer has the option of cashing you out of their plan. The account balance determines whether they can do this by distributing the money as cash or rolling it over into a retirement account.
In any event, you will be notified at least 30 days in advance of the company’s action. You can generally inform them of your preference at that time.
With the funds from that old account, you could open a traditional or Roth IRA to add to your savings. Or do a direct 401(k) rollover. SoFi makes the direct rollover process streamlined and simple.
FAQ
Can your employer force you to cash out your 401(k)?
Yes. If you leave your job and your 401(k) balance is less than $1,000, your ex-employer can cut you a check for that amount. Keep in mind that a 401(k) cash distribution is subject to ordinary income tax; you may also pay a 10% early withdrawal penalty if you’re younger than age 59 ½. For larger balances, you’ll likely have a rollover option, even if your consent isn’t required. If your balance is more than $5,000, the IRS requires your ex-employer to get your consent before doing anything with the funds in your account.
What happens when your company no longer offers a 401(k)?
When an employer opts to terminate a 401(k) plan, they’re required to make sure employees are able to access the full amount of their 401(k) savings. Assets are usually distributed within a year or so. You may be given the option to withdraw the balance in cash or put it into a rollover IRA in order to avoid negative tax consequences.
Can your company kick you out of the 401(k) plan?
A company can cull its 401(k) plan enrollment by forcing out ex-employees who are no longer active plan participants. If you’re forced out of a former employer’s 401(k), you may opt to receive a cash distribution, or you may wish to roll the money over to your current employer’s retirement plan. Your former employer may also have the ability to transfer your 401(k) funds to an IRA for you.
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