401(k): You can (and should) take it
You just got a new job, and there are dozens of things
to take care of during your last two weeks with the company. What
to do with the $3,642.08 you've accumulated in your 401(k) may not
be a priority.
So you just leave it there.
A lot of people do the same thing, leaving their 401(k)
with their former employer either because they like the plan and
think the money will grow, or they just don't know what else to
do with it.
The problem is, many companies are cashing out those
accounts, and former employees are finding a check in the mail --
quite a bit short of what they thought was in the account.
By law, former employers can cash out any 401(k) that
contains $5,000 or less. An effort must be made to locate the former
employee to see if they want the check mailed to them or to the
administrator or custodian of another retirement plan.
In some cases, the former employee may be difficult
to locate. If several years have elapsed, they may have hopped on
to a third or fourth employer and moved a time or two.
And even if they get the notice, a lot of people just
ignore it, says Rick Meigs, president of 401(k) HelpCenter.com.
"The 402(f) notice has to be sent within a reasonable
period of time before the distribution is made. It's five to seven
pages and a lot of legalese. A lot of people just don't understand
it and ignore it. Then the employer just mails the check."
If the mail catches up with them, they'll get some
- The check will be minus 20 percent in federal taxes
with more due at tax time if their tax bracket is higher
- Any taxable portion not rolled over may be subject
to a 10 percent early distribution penalty
- State taxes possibly are due
This doesn't just affect the folks who left behind
a 401(k) with a low balance when they changed jobs. The crumbling
stock market means plenty of people who had more sizable accounts
are now in the same boat.
"It's the case for a lot of people who may have
had an $8,000 or $9,000 balance and now have a 40 percent or 50
percent decline," says Meigs. "Sponsors don't have to
maintain those accounts in the plan and most are being fairly aggressive
in moving those accounts out of the plans. It's usually a cost issue."
A solution in progress
Lawmakers are in the process of coming up with a better solution
to this situation. Companies will have to put the low-balance 401(k)s
in an IRA if they don't hear otherwise from the former employee.
This means the accounts won't automatically be cashed out and no
taxes or penalties will be due.
According to Meigs, 68 percent of participants who
receive a cash distribution from a plan spend it rather than rolling
it into a new retirement plan.
Ted Benna, the man credited with creating the 401(k)
and president of the 401(k) Association, says anything that keeps
people from cashing out is a good idea.
"If a person job hops three or four times, cashes
out and doesn't roll over, potentially, that could mean a person
gets into their 30s and is starting with nothing toward retirement."
Unfortunately, the new law could be a couple years
away from taking effect. The Department of Labor must first come
up with rules regarding the designated IRAs that companies will
use for this purpose.
While the new law will be an improvement, Ginita Wall,
a certified financial planner based in San Diego, notes that the
IRAs probably will be low risk and low return.
"My guess is employers will set up the IRAs in
a money market account. I can't imagine the employer accepting the
liability of investing in equities. Fixed income might keep up with
inflation, but nothing more. I can't imagine they'll force employers
to do anything risky with this rule."
Fixing a cash-out problem
If you left a 401(k) behind and received a check minus the 20 percent
tax withholding, there's a way to correct that situation if you
want to put the money in an IRA and be credited for rolling over
your entire 401(k) balance.
If you can come up with the 20 percent, use that plus
the check you received from your former employer to open an IRA.
The 20 percent that was initially deducted will be credited toward
your tax bill at the end of the year. Remember, this has to be done
within 60 days of receiving the check.
But the best advice is to ask your employer for a
distribution form when you're about to leave a company. Make your
wishes known at that time about how you want your 401(k) to be handled.
"Usually, there's no real advantage to leaving
it there," says John Lindsay, investment representative with
Edward Jones Investments in Simi Valley, Calif. "They should
get the money in their control and it will become something that's
a valuable asset for them 15, 20, 30 years later."
While some companies offer employees a wide array
of 401(k) investment options, many plans remain extremely limited,
according to Diane Maloney, a certified financial planner at Beacon
Financial Planning Services in Plainfield, Ill.
"Most company plans that my clients have, have
few choices. There may be five or six and they may be a hodgepodge
that doesn't reflect the possibilities people have with the mutual
funds offered at a brokerage."
Whether you open an account with a brokerage or a
bank, there are guidelines for investing your nest egg.
Generally, if you're at least 10 years from needing
retirement money, you should invest for growth. Money you'll need
in three to 10 years should be in balanced funds -- a mix of stocks
and bonds. Money you'll need in less than three years should be
in fixed income.
It's always best to get some professional guidance
about how your money should be invested. Even if it costs a couple
hundred dollars to have a financial
planning expert assess your needs and work up a plan for you,
that may be a lot cheaper than making investment mistakes.
-- Posted: May 20, 2004