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Booted From A 401(k)? Don't Despair

It’s bad enough to lose a job.  But some employers may add insult to injury by kicking you out of their 401(k) plan as well.  Although this action sounds harsh, it’s within the legal rights of employers who hand out pink slips to employees with small plan balances.

According to the independent benefits consulting firm Aon Hewitt, approximately half of the companies sponsoring 401(k) plans nationwide in 2011 automatically rolled over to IRAs the plan assets of former employees with accounts valued at less than $5,000.  That is the threshold permitted by federal tax law since 2005, when the ceiling was raised from $1,000. In just six years, the number of such rollovers increased by one-third.  Employers also can force ex-employees to cash out if they have less than $1,000 in an account.

Although many employers first viewed rollovers as more of a hassle than a convenience, the gradual accumulation of small accounts drives up administrative costs for a 401(k) plan. So it turns out to be more cost-efficient for firms in the long run to set up IRAs for former workers than to keep them on 401(k) rolls.

The technique also tends to reduce plan fees for remaining plan participants.  Those fees are generally lower if there are fewer, larger accounts to administer.  For example, in a $10 million plan with an average account balance of $10,000, investors typically pay annual fees equal to 1.44% of their balance, according to the 401(k) Averages Book, an industry reference.  In a comparable plan in which the average account balance is $50,000, the fees are only 1.2%.

But what’s good for your former employer may be unwelcome news for you if you’re booted from the plan.  One issue is the difference between fees for “institutional” mutual fund shares that investors in 401(k)s typically pay and the higher “retail” fees that could apply to investments in an IRA.  Paying more in fees could cost you thousands of dollars over the long haul because of the loss of tax-deferred investment compounding.

What can you do if you lose your job and you’re forced to leave a 401(k) plan?  Just because you have to take your money out of that plan doesn’t mean you should withdraw it entirely and spend it now.  Not only would that undercut your long-term retirement savings plan, but it also would mean an immediate tax bill on the withdrawal.  In terms of taxes and your finances, it’s better to keep the money in the IRA, where earnings are shielded from current taxes, and then to roll over the assets into another 401(k) plan with your new employer.  That would put you back on track for more savings during your career.  Meanwhile, if you don’t like the IRA provider your ex-employer saddled you with, you always can shop around for another one.  We can help you weigh your options. 




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