This fall, the Department of Labor is likely to finalize regulations that will make it more expensive to dispose of small-balance ($1,000 to $5,000) 401(k) plans of ex-employees. But before the rules go into effect, many employers are busy cleaning out the small accounts while they still can do so on the cheap.
The new regulations will require companies to set up individual retirement accounts (IRAs) for 401(k) accounts they want to remove. According to Matt Hutcheson, a Portland, Oreg., pension consultant, that could be expensive. “It’s nearly impossible to find an institution that is excited about receiving these small accounts,” he says. Until the rules are passed, however, employers can jettison plans under $5,000 and avoid having to set up the IRAs. With the market decline, this category is growing. (Accounts with larger balances are required to stay in the plan if the employee chooses.)
The way some companies are cleaning out low-balance plans, though, has angered ex-employees and employee-benefit advocates. Some employers are simply mailing a check for the balance–minus a 20 percent withholding tax–to employees with little explanation. “Most of the participants who get a check spend it and pay a tax penalty,” says Rick Meigs, president of 401khelpcenter.com. “They don’t think it’s enough to affect their retirement, but often it is.”
Meigs advises companies to let ex-employees know about their options in writing. “Giving former employees one last shot at rolling the money into an IRA or new-employer plan is the best thing to do,” he says. Better communication will also save employers the headache of receiving calls from former employees who don’t know what to do with the check. “These small accounts can be an administrative nightmare,” says Hutcheson.
Pay Plus Benefits Inc., a Kennewick, Wash.-based employee leasing company, has a process in place to deal with small-balance accounts. The company runs a monthly list of terminated employees, sends out a notice advising them of their options, and gives them 60 days to take action. “It’s very easy for them to forget about the account,” says controller Diana Minard. She adds that companies that let these accounts build up over time will have a hard time tracking down the former employees later.