Attention Plan Sponsors:

 

My Employee Left the Company – What Should They Do with Their 401(k) Plan?

How to Help Your Employees Rollover Their 401(k) Plan without Disrupting Your Bottom Line

As an employer, you make it a point to provide benefits to your employees. These benefits often include a retirement plan, such as a 401(k) plan. The goal is that these types of benefits keep employees motivated to work with your company for years to come.

However, life happens. As a result, some employees may leave your company. Maybe they are terminated due to any number of reasons. Maybe they decide to quit and move on to another company or change career paths all together.

Whatever the reason, they need to rollover their 401(k) plan to an independent retirement plan or a plan with their new employer. What does this mean for you and your business? Read on to learn more about 401(k) exit strategies and how you can help advise your employees appropriately.

What Are the important Factors to Consider Regarding a Participant Exit Strategy?

Choosing the right 401(k) exit strategy for participants is an important part of their retirement planning. As a plan sponsor, you must consider various factors, such as age, taxes, and an individual’s potential life situation.

The key is to make sure you have an exit strategy designed to help employees roll over their retirement savings plan easily.

Can a 401(k) Plan Balance Get Rolled into an IRA?

One of the most advantageous options for employees is to roll a 401(k) plan balance into an IRA. It allows employees to consolidate money from your company’s plan as well as rollover money from other employee sponsored plans they had before your plan and will have after your plan.

Additionally, if your employee has some of their 401(k) money in a designated Roth account, your employee can roll this money into a Roth IRA. This offers the advantage of not having to take the required minimum distributions on this money when they reach age 72.

The truth is that rolling money 401(k) money into a Roth IRA offers several benefits, such as:

• An IRA will offer a wider range of investment choices than a 401(k) plan. This strategy allows you to incorporate this money into the strategy your employee has in place for other investment assets.
• Investing via an IRA is often a lower-cost alternative , especially if their former employer’s plan was a high-cost plan.
• People will work for a number of employers over the course of their career. Consolidating old 401(k)s and other retirement plan accounts in one place helps to ensure that retirement assets in old employer plans will not fall off the radar.
• If your employee had other assets in  their 401(k), such as mutual funds, this money would be rolled over to an IRA as normal.

The benefits associated with rolling a 401(k) plan into an IRA plan can also apply to a reverse rollover. Though not a direct rollover from a 401(k) plan, a reverse rollover from a traditional IRA into a 401(k) plan can be a viable strategy for some employees.

A reverse rollover can consist only of IRA funds that were originally contributed to the IRA or a prior 401(k) plan on a pretax basis. Funds contributed on an after-tax basis are not eligible.

However, there is a disadvantage to rolling a 401(k) plan into an IRA. An IRA does not offer creditor protection in the same manner in which a 401(k) plan does.

Can an Employee Roll Their 401(k) Plan into Their New Employer’s Plan?

Many times, an employee will move on to another employer. As a result, it would make sense to roll their existing 401(k) plan into their new employer’s plan. However, advise your employee that their new employer may not accept rollovers from other 401(k) plans. Additionally, advise your employee to review the new employer’s plan to ensure it offers a solid, low-cost investing menu that fits their investing needs.

Rolling their current 401(k) plan into their new employer’s plan may offer some of the following benefits: 

• If creditor protection is an issue, the new employer’s plan will offer this as opposed to the limited protection that may be available in an IRA.
• If your prior employee wants to consider a Roth IRA conversion, including a backdoor Roth, now or in the future, rolling their 401(k) plan into their new employer’s traditional 401(k) plan eliminates adding more to their traditional IRA balance. This will lessen the impact of the pro rata rule on future conversions, saving taxes in the process.
• If your employee is 72 or nearing that age and plans to continue working, moving this balance to the new employer’s 401(k) may allow them to defer taking required minimum distributions on this money.

Can an Employee Withdrawal All or Part of the Money in the 401(k) Plan?

While an employee is welcome to withdrawal all or part of the money in their 401(k) plan, it is not recommended. However, it is understood that in some cases, they may need to take part of the money to hold them over between employment opportunities.

In these cases, the rule of 55 may be a great benefit. When an employee reaches the age of 55, they can withdraw money from their 401(k) penalty-free. However, they must still pay taxes on that money.

Further, if an employee is at least 59½, they may consider withdrawing some of the money if needed to fund early retirement needs and then roll the rest over to an IRA. In the case of a traditional 401(k) the money will be taxed, but there will be no penalties. In some cases, this option may be a wonderful way and solid strategy for employees to enter early retirement.

If your employee has a Roth 401(k) and they are 59½, any withdrawals will be tax-free as long as they have met all other criteria for a qualified distribution. Again, this can be a good strategy to fund early retirement needs or other needs these employees may have.

Another option for your employee, if the plan allows for it, would be to withdraw all or a certain amount of their current 401(k) prior to age 59½. They can use the series of substantially equal periodic payments, or SOSEPP, method. Under this option, your employee can take a series of distributions and pay taxes only on the amount distributed each year instead of a larger amount in a single year when leaving your employ.

[NOTE-A SOSEPP could be done via rolling the money to an IRA and then taking the payments from the IRA. This option could conceivably be done by leaving the money in your plan as the prior employer, and then taking the withdrawals from there. However, they will want to have make sure your plan will allow for this option.] 

There are strict rules on SOSEPPs. They must be followed in order to avoid triggering unwanted taxes and penalties. These rules include that the SOSEPP must continue until your employee reaches age 59½ and must last for at least five years regardless of age.

Conclusion

Your employees may need help determining the best course of action regarding their 401(k) plans if and when they leave your company. As a result, you may need help to advise them when it comes time for their exit strategy. Retirement Plan Services Group can help lead you and your employees through the exit strategy best suited for their needs. Our guidance will help ensure your employees are provided for and you do not waste valuable time, money, or resources in helping them move on to their next adventure. Please call us at 609-922-0201 to learn more.