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Rules change on low-balance 401(k)s

A new federal rule protects employees who leave behind a low-balance 401(k) when they quit working for a company.

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Many workers neglect their 401(k)s when they change jobs or simply leave the company. Sometimes it's because they like the plan and think the money will grow; sometimes it's because they don't know what to do with it.

Under previous federal rules, accounts with a balance of less than $5,000 could be cashed out if the former employee didn't provide instructions on what to do with the account. The new law says that accounts with a balance of $1,000 to $5,000 must be rolled over to a safe harbor account -- an IRA.

The accounts would be designed "to minimize risk, preserve assets for retirement and maintain liquidity," according to the U.S. Department of Labor. The labor department recommends funneling the money into money market funds, interest-bearing savings accounts and certificates of deposit.

"Consumers need to know that this is their account," says Rick Meigs, president of 401khelpcenter.com, "that they have the right to the money and can do anything they want with the account just as if they set it up themselves.

"But, by definition, most of them aren't going to know that it exists. By definition it's only set up where the plan sponsor is unable to locate the plan participant or where the participant fails to respond."

Accounts with a balance of less than $1,000 can be cashed out by the employer if the participant is located. The check will be minus 20 percent in federal taxes, with more due at tax time if the individual is in a higher tax bracket. In addition, any taxable portion not rolled over may be subject to a 10-percent IRS penalty. And, state taxes may be due. If a participant can't be located, the money would stay in the 401(k) and, likely, be eaten up by fees pretty quickly.

Meigs says he suspects that a lot of companies will simply allow balances as low as $1,000 to stay in the 401(k).

"There are two approaches. Companies can set up these accounts and roll over the small-balances in accordance with the regulations, or they can amend their plan. There's no magic about $5,000. The rule changes the amount they can distribute to $1,000. They can just leave (balances above that) in the 401(k). Don't take any steps to distribute it; don't search for the person."

If you leave a 401(k) behind and receive a check minus the 20-percent tax withholding, there's a way to correct the 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. 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.

 
-- Updated: April 26, 2005
   

 

 
 

 

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