Are 401k's from former employee a problem?

I'm new to this and I heard that when people leave a company, they tend to leave their 401k behind. Is it a big problem for the employer to keep all those orphaned 401k's? If so, how should we encourage people to rollover their 401k when they leave? Thanks!

Who is "we"?

Welcome to the message boards, Shuo!

I don't have a survey to back this up, but I'd guess that the median participant wants 2-3 years before taking a distribution of his or her account from a 401(k) plan.  Most of the time the distributions are rolled into an Individual Retirement Account.  Obviously, there is lots of variation around that median case.  So a participant might not take a distribution right away but they usually aren't leaving their money in their former employer's plan for a really extended time period either.

If a participant's vested account balance exceeds $5,000 (depending on the plan document, this might exclude any rollover contribution account), then a distribution can't be made without the participant's consent.  A plan could force out a distribution as early as age 62 for those with vested account balances > $5,000, but this almost never happens.  So, one has to deal with account balances of terminated vested employees.

It's not much of a problem though.  Recordkeepers are pretty good these days minimizing lost participant problems.  It may be helpful to keep those accounts in the plan:  they give the plan a greater pot of assets, which allows one to purchase more economical investment management.

David, "we" is "the employer" here

@MWeddell  thanks for the detailed reply! Do you know if employers still have to pay fees for the former employees' plans?

It depends on the service provider and the terms of the service contract but if there is a per participant charge, the terminated participants with a balance are usually included in any billing charges.

@Lou S. that makes sense. In that case, shouldn't the employer try to encourage the former employees to rollover? Is there any service to help the employer do that? Or is the charge not that much and the employer just does not bother?

Our plans have a cash out provision of $200, so anyone with a balance of $200 or less can be forced out.  Most of our clients do pay a fee on their participant balances.  I find that most of our participants take their money, or roll it over to a new plan or IRA.

The requirement for an audit attachment to the Form 5500 is (mostly) related to plan size, so some plans that are close to the threshold might eliminate (or avoid) the audit expense by encouraging a few distributions.

@david rigby that's an interesting reason for encouraging distributions! Other than that, would you say keeping former employees' 401k is generally not a pain point for employer?

There might be other conditions. 

• Does keeping them in the plan help or hurt the overall plan efficiency?  (Other readers may have already crunched the numbers on this.)
• Are there any assets that are unavailable as alternative investments because the plan falls below a particular $ threshold? 
• Is there a likelihood of former employees to become "missing"?  (Yes.)
• Etc.

9 hours ago, Shuo said:

I'm new to this and I heard that when people leave a company, they tend to leave their 401k behind. Is it a big problem for the employer to keep all those orphaned 401k's? If so, how should we encourage people to rollover their 401k when they leave? Thanks!

First: where did you HEAR that?  Always be suspect of "hearing" things.  They usually are not true.

Second: What kind of a problem are you asking about?  Normally, the employer isn't doing anything special since the admin service is doing all the work.

Third: Who are YOU when you refer to "we" in the encouragement issue. Why do you care?

Fourth: Almost all of our plans provide for a lump sum distribution to be available after the year is over in which the participant terminates and the annual work is done for that year, and almost all of the  participants take their money at that point. We see very little evidence of people leaving their money with their ex-employer.

Just some things to add to the discussion. Welcome aboard.

Larry.

I agree with the earlier post that if there is a per participant charge, this includes terminated vested participants.  Sometimes that fee is paid by the employer but sometimes it is paid by the participant.

@Larry Starr thanks for the reply and those are good questions! Here is the background: I heard from one of my financial advisor friends that there are a lot of orphaned 401k's, so much that a bill called "Retirement Savings Lost and Found Act of 2020" was just introduced, which says 30% of employees have left their retirement accounts with previous employers. I'm a startup founder so I became interested in knowing more about this problem and whether this will impact me or any employer in general.

So when I say problem, I meant "will it be a burden for the employers if their former employees left behind their 401k's?" The burden can be financial burden (fees etc), administrative burden or any burden that I am not aware of. Or if most of the work is done by admin service/consultants, is it a problem for them?

SHUO---

I agree with you that for some people, inertia takes over and they just forget to move their funds, except in this economy maybe less so.

I have seen  a couple of pros and cons of keeping your retirement benefit with your former employer on web sites from some of the large mutual fund houses 

in my memory (they helped me to make my decision for two fairly large rollovers). One of the big issues I found is that an IRA provider might not conceivably provide fund fees as low as a

large employer--this was more true  20 years ago than now- most mutual fund fees especially indexed funds are now historically low for both IRA providers and plan sponsors. One

academic issue I also remember is that IRA assets might be lost in a bankruptcy of the provider whereas qualified plan assets can not be, but that is more an academic  argument today---ie,

if a Vanguard or Fidelity go under, we're all in trouble. One other wrinkle: I believe that  advising a participant as to what to do with their funds (stay or rollover) may now  potentially trip the

new fiduciary rules, so it's an  area to be careful about. Hope that helps.

On the subject of fees for participants who either cannot be (or choose not to be) cashed-out, the IRS doesn't like to see a "significant detriment" on their ability to leave their money in the plan. See Revenue Ruling 96-47 and Revenue Ruling 2004-10. (That doesn't mean you can't charge reasonable fees.) There might be language in the plan document reflecting this guidance that you would need to observe if the plan's language is more conservative than what you think the law provides. The document might also fail to contain a mandatory cash-out at age 62/NRA even though a plan can be drafted to contain a mandatory cash-out at age 62/NRA. I have seen documents that continue to require consent even after the time described by IRC 401(a)(14), i.e., participants may choose to keep their money in the plan for life. For such a document, you would want to establish what preapproved cash-out provisions are available and which are not (as a matter of product design) before signing on the dotted line.

20 hours ago, Bob the Swimmer said:

if a Vanguard or Fidelity go under...

Huh???  I am not sure what scenario you are thinking of for this.

Vanguard itself is owned by the Vanguard mutual funds (it is a mutual, mutual fund company), and the Vanguard mutual funds are owned by the shareholders of the funds.  The investments of the mutual funds are really well diversified, so I am not sure how "Vanguard" could go under.  Maybe it's possible, but it seems like they would have to purposely try to go under.  

Also, I think you are also mixing up provider bankruptcy versus personal bankruptcy.  Creditors could get IRA assets pre-BAPCPA of 2005, but no longer. 

Shuo, if you are thinking of starting up a plan for your new business, there are some things you will want to consider with respect to this issue of terminated employees leaving money in the plan.

1. You can write the plan to say that if the terminated employee's account is less than $5,000, then if they do not affirmatively elect to withdraw their money, the plan will force out the account.  It will be paid to the employee in cash if it is less than $1,000 or rolled over to an IRA if over $1,000.

2. When the employee terminates, immediately give him the necessary paperwork/forms to request a withdrawal.  Make it as easy as possible for him to process the payment.  You can also make a point of sending distribution reminders to terminated employees each year.

The benefit of having the terminated employee remove the money from the plan is that the company may be paying fees on those people, to the recordkeeper or the TPA, which you can reduce by getting those accounts out of the plan.  The biggest issue I see with having terminated accounts sit in the plan is that over time, as people move, the employer no longer has valid addresses for those employees and they  become "lost" and as the plan sponsor you have a responsibility to be sending certain required notices to those employees, which you are unable to fulfill because you don't have a good address for them.  

So I think you do want to try to encourage them to move their money once they terminate.  But, legally, to the extent that the account is over $5,000, you cannot force them to withdraw the money until retirement age.  Some employees will choose to leave their money in the plan because the investment fees may be lower for them there than what they would pay on the open market.  Just be very diligent in keeping up-to-date address info for terminated employees who do choose to leave their money in the plan. 

One often overlooked advantage from the participant's perspective to doing a direct rollover is the ability to take partial withdrawals if/as possibly needed, and to do so without 20% mandatory withholding. Few smaller plans permit partial withdrawals (all or nothing). Your plan's investment advisor should be a help in communicating the distribution options to terminees, and many institutional recordkeepers provide a free rollover service (to their own IRA, of course). Millenium Trust and PenChecks are two independent companies that offer solutions for lost inactives (i.e. terminated participants with vested balances) and returned or uncashed distribution checks.

3 hours ago, AKconsult said:

Shuo, if you are thinking of starting up a plan for your new business, there are some things you will want to consider with respect to this issue of terminated employees leaving money in the plan.

1. You can write the plan to say that if the terminated employee's account is less than $5,000, then if they do not affirmatively elect to withdraw their money, the plan will force out the account.  It will be paid to the employee in cash if it is less than $1,000 or rolled over to an IRA if over $1,000.

2. When the employee terminates, immediately give him the necessary paperwork/forms to request a withdrawal.  Make it as easy as possible for him to process the payment.  You can also make a point of sending distribution reminders to terminated employees each year.

The benefit of having the terminated employee remove the money from the plan is that the company may be paying fees on those people, to the recordkeeper or the TPA, which you can reduce by getting those accounts out of the plan.  The biggest issue I see with having terminated accounts sit in the plan is that over time, as people move, the employer no longer has valid addresses for those employees and they  become "lost" and as the plan sponsor you have a responsibility to be sending certain required notices to those employees, which you are unable to fulfill because you don't have a good address for them.  

So I think you do want to try to encourage them to move their money once they terminate.  But, legally, to the extent that the account is over $5,000, you cannot force them to withdraw the money until retirement age.  Some employees will choose to leave their money in the plan because the investment fees may be lower for them there than what they would pay on the open market.  Just be very diligent in keeping up-to-date address info for terminated employees who do choose to leave their money in the plan. 

 

We've had situations where the employee just calls the employer one day and says that he is "quitting"... and never shows up again.  Others just don't show up for work... with no contact with the employer.  No valid addresses in either case.

And, terminated employees that "move on" with no current addresses and become "lost" is a major problem if and when the plan terminates. 

4 hours ago, chc93 said:

We've had situations where the employee just calls the employer one day and says that he is "quitting"... and never shows up again.  Others just don't show up for work... with no contact with the employer.  No valid addresses in either case.

And, terminated employees that "move on" with no current addresses and become "lost" is a major problem if and when the plan terminates. 

At plan termination is when the problem of lost participants go away.  Because at plan termination, we can do a mandatory rollover for participants who cannot be found, regardless of the amount.  Our plans have that language and yours probably do too.  Our rollover company get the SS number and LAST KNOWN ADDRESS; they are experts at finding people, and even if we don't have last known addresses, they will work with just the SS number and still most likely find the person.  More importantly, it ain't our problem any more when the funds have been sent off to the IRA provider.

Sounds like we use the same auto-rollover provider Larry does.  They also accept auto-rollovers of less than $1,000.  All of our plans that auto-roll apply it to all balances under $5,000.  That takes care of the problem of terminated participants with a small balance who disappear.

I'm probably on the short side of this one - but to answer the OP's question, it is *NOT* a problem for the employer to have all of those terminated participant's accounts in the plan.  Indeed, the employer might not have a choice in the matter.  Second, these are *NOT* "orphaned" accounts.  Most people are fully aware of their balances in the plan (at least if it's substantial) and choose to leave it there.  I for one have money in my current employer's plan, and three previous employer plans.  I do it for several reasons - including 1) I like the investment options offered; 2) I like that those investments are "institutional class shares" priced at a level that I can't match in a retail IRA account (and one of my former employer's, who shall remain nameless, but the Chairman use to advertise that you can "talk" to him) makes about 5 times as much on an IRA as they do on money in a plan (and they, as a financial services company that provides services to retirement plan is in the business SOLEY to attempt to capture rollovers); and 3) for competitive intelligence purposes (I get to see the new bells and whistles others roll out!).  J/K on the last one (but I do compare).

In my experience, some (many?) employers actually take a paternalistic view on this and try to keep money in the plan.  It might benefit the plan (more purchasing power), and provided they are well above the audit threshold number, it isn't too problematic.  Fees can be past through to terminate participants (only) if they so choose, and you may have a problem with missing participants - but otherwise, not a problem.