Money at 30: Beware the 401(k) “Force Out”
One of the benefits of writing about personal finance is that, when I find myself in frustrating financial situations, I at least enjoy the silver lining of getting an article out of it. This is what I had to remind myself of yesterday as I spent a nice chunk of my morning on the phone with Wells Fargo. Why? Well, just as I’m constantly learning about new aspects of personal finance, yesterday I was introduced to the concept of a 401(k) “force out” in the rudest of ways.
My 401(k) Force Out Experience
Logging onto my Wells Fargo account yesterday, I was intending to see if a direct deposit I was expecting had completed. Instead I noticed that my 401(k) — which is the result of a part-time job I left a few years back — had suddenly dropped from north of $500 to $0. To ensure this wasn’t some sort of glitch, I dove into the transaction history only find a distribution had been issued on August 1st.
My first thought was that someone had managed to log into my account and send my money off elsewhere (something that happened to me with my Starbucks Gold Card). However it seemed odd that they would go through the trouble of emptying my dormant 401(k) and not my regular checking account. So after a quick Twitter search to see if anyone else was experiencing such an issue, I decided to call and see what I could learn. (Sidenote: I double checked the number multiple times after getting spooked about entering my social security number into the automated service.)
Once I finally got through to a representative, she broke the bad news to me. Apparently, since my account had remained under $1,000, I had been forced out of my account and a check had been issued to me. Adding to the issue, I learned that the mailing address for my 401(k) account was outdated despite my regular Wells Fargo account bearing the correct info. In other words, they mailed the check to the wrong place. I will say I’m also unsure if this address error meant they did try mailing me warnings about an impending force out as well, but there were no alerts on my online account nor did they e-mail me.
In the end, this part of the mishap may have been for the best as it gave them a reason to stop the previous check and reissue one. As a result (and after some back and forth), I was able to request that the distribution be made as a direct rollover to my — ahem — Wells Fargo IRA. Although it seems that everything will now be resolved, I wanted to take a closer look at what went wrong and how bad it could have been.
What is a 401(k) Force Out?
Following this debacle, I decided to get a better understanding of what exactly had transpired. That’s when I came across a U.S. News article explaining the concept of a 401(k) force out and what your former employer is allowed to do.
According to them, your plan can elect to close your account without your permission if you are no longer active with the company and have less than $5,000 in it. If you have between $1,000 and $5,000 in your account, they may rollover your balance to an IRA of their choosing. Meanwhile, if you have less than $1,000, they can choose to distribute your balance in cash (which is clearly what happened to me).
This could be a major problem for part-time employees who may not be contributing large amounts to their account (I actually think the majority of my balance was profit sharing). Similarly those with multiple jobs and, thus, multiple 401(k)s all sporting smaller balances could also be negatively affected by these rules. That’s because the implications of these force outs could be money down the drain.
Why You Need to Watch Out for Force Outs
On the one hand, getting a check for a few hundred dollars you weren’t expecting may seem like a blessing — until you realize what it actually costs you.
First of all, Wells Fargo charged me a $40 distribution fee as the result of my force out. Next, had the cash distribution remained in effect, federal and state taxes would have been deducted from the amount. In my case, this meant my balance went from a total of $530 to $490 after the distribution fee and down to $380 after taxes.
But wait — there’s more. Not included in the withheld taxes was the 10% early distribution penalty I’d be subjected to since I’m under 59 1/2. When I inquired about whether this was also factored into my distribution, the operator informed me that I’d be responsible for paying this fee come tax time. This would take my net total to less than $350.
Thankfully, by rolling the money over to my IRA, I’ll get to keep the $490 (no getting around the distribution fee, sadly). Moreover this amount will hopefully continue to grow along with my other retirement savings, making it by far a better option than taking my cash out now. After all, even if it is only a few hundred dollars now, who knows how much it could turn into by the time I reach retirement age?
As for those with higher balances but are still under that $5,000 threshold, U.S News also notes that, since plans get to choose what kind of IRA balances may be transferred to, these accounts may include high fees and low returns. Because of this, forced rollover balances tend to actually decrease instead of increase with time. The site even reports that the average $1,000 account transferred to one of these IRAs is likely to decrease by about 25% over 5 years. Clearly this is hardly any better than taking the cash out and paying the penalties.
What You Can to Do Instead
When I left my last job that offered a 401(k) and resulted in that few hundred dollar balance, I decided to keep it where it was because I was happy with the returns I was getting. Knowing what I know now, it probably would have been better to transfer that balance to an IRA (that I selected, not the plan) and skip this hassle. In fact, that’s what I’d now recommend to other workers with low 401(k) balances who are departing their jobs. Also keep in mind that your balance only includes your vested amount, so be sure to take this into consideration when exploring your options.
As for those with more than $5,000 in their accounts, it seems that keeping your money where it is may still be a viable option. That said, it’s probably a good idea to check up on it regularly — and update your contact information — just in case.
In the grand scheme of things, I was quite lucky to have been keeping tabs on my old 401(k) and to take notice when the force out occurred. Had I not been paying attention, it’s likely that I would have let $500 disappear — and then been assessed a $50 penalty on money I never received. Unfortunately I presume most workers aren’t as fortunate as I am and may be letting their earned savings be underutilized at best or completely pilfered at worst. Hopefully my recent experience with the concept of a force out can be a reminder to exiting employees to consider their 401(k) rollover options more carefully.