What to Know About Automatic 401(k) Transfers
Cashing Out Can Cause Fines and Fees
When people switch jobs, many of them choose to cash out their 401(k) accounts instead of moving money to another tax-advantaged retirement plan. When they do this, they are often charged taxes and 10% penalties. Workers also have to restart saving for retirement if they spend the money taken out of their 401(k) accounts. In order to avoid fees and fines, for employees, some companies are making the process of transferring these accounts easier when people change jobs.
For example, Alight Solutions LLC, a 401(k) record-keeping service, announced that it will offer automatic 401(k) transfers for employees changing jobs starting on January 1, 2021. The company serves about 185 401(k) plans, which have almost 5 million participants.
The Impact of 401(k) Cash-Outs
People changing jobs and deciding not to transfer their retirement accounts to their new employers is the largest source of what the industry calls “leakage.”
About 30% of people leaving jobs decide to withdraw the money in their 401(k) accounts. Of people with under $5,000 in their retirement accounts, about 80% cash out. Workers in low-income brackets, minorities, and younger people are more prone to taking money out of their 401(k)s when they move between jobs. Often, taking money out is easier than going through the process of transferring it.
A Few Things to Watch
Analysts estimate that wealth in retirement accounts in the US is reduced by about 25% due to people taking money out early. This is because people’s savings don’t compound when accounts are drawn down early.
Currently, the law stipulates that if a former employee’s 401(k) balance is under $1,000, employers can mail a check to them, which makes cashing out easier. If that employee has a balance between $1,000 and $5,000, however, employers either need to keep the money in the plan or transfer the funds to an IRA if not instructed to do otherwise by the employee. The catch is that because of Labor Department regulations, those IRAs are usually invested in certificates of deposits or money market funds—which are safe but offer very low returns. Oftentimes their returns don’t even cover investment fees.
Although the coronavirus has been a disruptive event for the labor market, it may be a smart time for employees to revisit guidelines around employers’ 401(k) plans, especially since some may be offering new automatic transfer options.
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