Distributing abandoned small accounts in the 401(k) plans of participants who have left the company is a necessary evil for plan sponsors, to keep the plan focused on managing larger, active holdings and controlling costs. Despite the benefits for the plan that this form of housekeeping provides, results from these “forced transfers” may be less beneficial for participants.
A review by the U.S. Government Accountability Office released Dec. 22 suggests giving plans default alternatives beyond individual retirement accounts — including an automatic cash-out option — when transferring small abandoned accounts, to channel the money away from higher-fee options.
The agency found in its study of the forced-transfer process that IRA fees often outpaced returns for smaller accounts, leading the balances to decrease rather than grow over time. Members of Congress have expressed concern about this inadvertent penalty that participants changing jobs and leaving retirement savings behind may face.
What’s a Forced Transfer?
A forced transfer occurs when a plan participant has separated from an employer, but still has vested savings in the employer’s 401(k) plan and the plan sponsor decides not to allow the savings to remain in the plan. Before the Economic Growth and Tax Relief Reconciliation Act of 2001, plans could, in the absence of participant instructions, distribute balances of not more than $5,000 by paying them directly to the participant, referred to as a cash-out.
EGTRRA sought to protect forced-out participants’ retirement savings by requiring that, without participant instructions, active plans transfer balances of $1,000 or more to forced-transfer IRAs, thus permitting the plan to distribute them while preserving their tax-preferred status, the GAO report said.
About half of active 401(k) plans force out separated participants with balances of $1,000 to $5,000, according to 2011 plan year data surveyed by the Plan Sponsor Council of America. And data from the U.S. Social Security Administration indicated that from 2004 through 2013, separated employees left behind more than 16 million accounts of $5,000 or less in workplace plans, with an aggregate value of $8.5 billion, the GAO report said.
GAO in the report also recommended repealing a provision that lets plans disregard larger rollover amounts included in departed participants’ accounts when identifying eligible balances of $5,000 or less for IRA transfers. As a result of this rule, accounts of significant size can end up in forced transfers when participants don’t indicate what should be done with the money once they’ve left.
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