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What Employers Need to Know About 401(k) Rollovers

by Tony Blasini, CPC, QPA
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iStock_000004385689 low res.jpgWhen an employee leaves your company, there’s a number of ways to handle the investments in their 401(k). You and the employee that’s leaving need to understand what’s the best fit for the money in question, such as whether to utilize 401(k) rollovers or withdraw the funds. Below we’ll discuss the pertinent benefits and costs to help you make the right decision.

Notice Period

Employers do not have the right to rush exiting employees into making a decision about how to handle their 401(k) rollovers. The beneficiary has a minimum of 30 days to make their decision, although if they’ve already decided on how to handle the funds, they can waive the right to this notice period. Employers are expected to process the funds accordingly as soon as it is administratively possible.

401(k) Portability

The exiting employee (that is, the beneficiary of the plan) has three basic options for what to do with their 401(k): cash it out, leave it behind, or roll it over into another savings plan. However, in some cases, the employer does have influence. Here we’ll give an overview of each.

Payment to Beneficiary

The beneficiary may choose to cash out their 401(k) in two ways: an indirect rollover (i.e., the employer pays the beneficiary, and the beneficiary deposits that money into a new plan), or complete withdrawal. Either way, the employer withholds 20% of the total funds for taxes. If the beneficiary is younger than 59 ½ years, they will owe the IRS another 10% as an early withdrawal penalty, and the funds will be subject to other federal, state, and local taxes. It’s worth noting that at 70 ½ years of age, there’s a required minimum distribution and other restrictions, even if the beneficiary continues to work.

They may choose an indirect rollover for any number of reasons, including not yet having a new job or to take advantage of a short-term loan. Once the employee receives their funds, they have 60 days to deposit the money into an IRA or the retirement plan from their new employer. Except in special circumstances, if the money hasn’t been deposited by the time the period has passed, the entire amount is considered to be withdrawn and subject to the above-mentioned taxes and fees. If they choose to do an indirect rollover, you do not pay out the 20% already withheld for taxes. If the beneficiary chooses to rollover the entire amount from the original 401(k), they are responsible for adding that 20% of their own funds in the expectation that the withheld 20% will be refunded when they file taxes.

Leaving the 401(k) Behind

For a beneficiary who has $5,000 or more, he/she may choose to leave the 401(k) behind. If they elect to do so, this does not take away their right to transfer or withdraw the funds at a future time. However, employers should not let the beneficiary continue to contribute new funds to the plan, and they are not required to allow former employees to borrow against the 401(k) they’ve left behind. Furthermore, employers are permitted to have a different fee plan for former employees.

Rollover the 401(k) to Another Account

The most common option is to execute a direct rollover into an IRA or new 401(k) plan. A direct rollover is one that is never transferred to the employee and thus does not trigger any penalties or extra taxes. However, it should be noted that employers are not required to accept 401(k) rollovers, and furthermore, are allowed to control when a new employee is eligible to take part in a new 401(k) (e.g., one-year minimums, enrollment periods).

Employer Prerogatives

When it comes to 401(k) funds that are below $5,000, the employer isn’t obligated to let an exiting employee leave their 401(k) behind. If the funds are less than $1,000, employers are allowed to automatically cash out the money. For funds between $1,000 and $5,000, employers may automatically roll the 401(k) funds into an IRA.

Whether they opt for a direct or indirect rollover, cash out, or to leave it behind, portability is a key feature of the 401(k). With what employers need to know about 401(k) rollovers under your belt, you’re in the position to make the best decisions for your business as well as your exiting employees.

About Caldwell Trust Company

Caldwell Trust Company is an independent trust company with offices in Venice and Sarasota, Florida. Established in 1993, the firm currently has nearly $1 biillion dollars in assets under management for clients throughout the United States. The company offers a full range of fiduciary services to individuals including services as trustee, custodian, investment adviser, financial manager and personal representative. Additionally, Caldwell manages 401(k) and 403(b) qualified retirement plans for employers.

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