Rolling Over Your 401(k) Shouldn't Be This Hard

The percentage of U.S. workers who have changed or lost their jobs in the last year is double the annual rate during the previous two decades. And with that turnover comes a trail of orphaned 401(k) retirement accounts.

Those who opt to take their money with them and roll it over into a self-directed individual retirement account, or transfer it into a new employer's 401(k) plan, are learning how arduous the process can sometimes be. With so many 401(k) providers offering different plans that operate under an assortment of rules, there's no uniform procedure for former employees who want to move their retirement savings.

In turn, there are no clear-cut answers to common questions such as: How do I transfer money in a 401(k) account under my maiden name? Do I have to withhold anything for tax purposes? What do I do if I have company stock in my 401(k)?

With the burden on participants to figure it all out, it's no surprise that more often than not, they just give up and leave their 401(k) accounts where they are.

And don't forget, it's generally a paper process to roll over retirement funds. Most forms to shift a 401(k) still have to be completed the old-fashioned way, and even if a retirement saver is successful in completing the transfer, the money is typically delivered via mail as a paper check. It's a woefully inefficient process for the 21st century, subject to delays and with no easy way to get status updates.

Until the process becomes more standardized and digitized, here are some things to keep in mind when deciding what to do with that 401(k) money and to ensure you preserve as much of it as you can. 

First, it's usually best to move the money as a direct rollover, which means the funds will be headed straight for a new account, not to the account holder. That way, the former employee doesn't have to have any taxes withheld. The paper check may still be sent to the participant, but it should be made out to, say, the new IRA custodian, rather than payable to the account holder.

If the check is made out to the account holder, the clock starts on a 60-day period for the money to make its way to the new account. Beware, if you choose to take the money directly as a distribution, you're subject to mandatory income tax withholding of 20%.

Also, remember, that if you've taken a loan from your 401(k), it's usually due when you leave your employer. If you can't pay it back when you depart, it will be considered part of your taxable income, and you could face an early withdrawal penalty depending on your age. While recent legislation relaxed the rules around repayment for individuals who borrow from their retirement accounts, loans are still due when employees move on.

For workers who have company stock in their 401(k)s, they may be responsible for calculating the cost basis on that stock, or the original value when they acquired it. If they roll over those funds, they should consider whether it makes more sense to put the funds in a taxable or non-taxable account, given special Internal Revenue Service rules governing the treatment of company stock in retirement plans.

What if the name on the account needs to be changed — say, the employee has gotten married? Unfortunately, questions about how to handle a name change generally require a call to both the old 401(k) provider and to the new custodian or provider. Be prepared to enlist the help of a notary.

Despite the hassles, it's still usually prudent to roll over money from an old 401(k) into a new retirement account. Even if you're organized and know you won't forget about it, if you've had multiple jobs and retirement savings at each, there often isn't diversification among the accounts in terms of what they're invested in and the risk level borne by each one.

Still, if you think the fees are low enough, the investment options are attractive enough, and you're willing to make sure you or a financial adviser can help coordinate everything, you may just want to stay put — especially if you'd be forced to liquidate holdings, which happens when workplace plans offer options that aren't available to retail investors.

But in a final blow, check what the minimum balances are. Some plans require account holders to have at least $1,000 invested, while others require $5,000 to maintain plans once workers move on. Depending on the size of your account, you may have no choice but to roll it over anyway.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, she oversaw tax coverage for Bloomberg News.

©2021 Bloomberg L.P.

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