Most people who have 401 (k) plans know the basics, your employer withholds pre-tax dollars from your paycheck and deposits the money in an account where you can invest it. You can decide how much of your paycheck goes to your 401 (k), and your employer may make matching contributions. The money grows tax-deferred until retirement, when you must withdraw a certain amount each year and pay taxes on it.
However, people generally don’t know as much about 401 (k) rights, especially in rare situations. Two of those situations include leaving the company and borrowing from your account.
- Your employer can withdraw money from your 401 (k) after you leave the company, but only under certain circumstances.
- If your balance is less than $ 1,000, your employer can write a check.
- Your employer can transfer the money to an IRA of the company’s choosing if your balance is between $ 1,000 and $ 5,000.
- For balances of $ 5,000 or more, your employer must leave your money in a 401 (k) unless you provide other instructions.
Your 401 (k) plan when you change employers
Your employer can withdraw money from your 401 (k) after you leave the business, but only under certain circumstances, as explained by the Internal Revenue Service (IRS).
If your balance is less than $ 1,000, your employer may write a check for the balance. If this happens, rush to transfer your money to an individual retirement account (IRA). You usually only have 60 days to do so or it will be considered a withdrawal and you will have to pay penalties and taxes. Note that the check will already have taxes deducted. You can refund your account when you reopen it.
A Plan Sponsor Council of America survey found that just over half of all businesses take this or next step for the next category of 401 (k) balances. If your balance is $ 1,000 to $ 5,000, your employer can roll the money into an IRA of the company’s choosing.
These mandatory distributions, also called involuntary cash withdrawals, have different thresholds, depending on what your employer has chosen. Your business doesn’t have to require withdrawals at all, but if it does, the highest threshold allowed is $ 5,000.Your summary plan description should detail the rules and your plan sponsor should follow them. The plan sponsor must notify you before moving your money, but if you don’t take action, your employer will distribute your balance according to the plan’s rules.
If your balance is $ 5,000 or more, your employer must leave your money in your 401 (k) unless you provide other instructions. However, there is a caveat, according to Greg szymanski, Director of Human Resources, Geonerco Management LLC: “These grandfathered account balances are evaluated each year based on the plan documents. So someone who is not in an automatic cash withdrawal or automatic reinvestment this year may find themselves in that position the following year if the stock market falls. ”
The $ 5,000 rule only applies to money deposited into your 401 (k) from earnings from the job you just quit. Let’s say you put $ 8,000 into that 401 (k) from a previous employer and contributed $ 4,000 after that. Your 401 (k) balance would be $ 12,000, but since only $ 4,000 was from the job you just left, you could still transfer your money to a forced transfer IRA.
Employers don’t make these rules cruel, they do it because it costs them money to manage each account. They also incur legal liability with each account they manage. Many employers want to eliminate those costs and responsibilities when it comes to former employees.
If your account ends up in a forced rollover IRA, you have the right to delete it to an IRA of your choice, so take a good look at the fees charged to you; you may be able to do better on your own.
What happens when you borrow
The rules about 401 (k) plans can seem confusing to workers. While employers are not required to offer the plans at all, if they do, they must do certain things, but they also have discretion on how to execute the plan in other ways. One option they have is whether or not to offer 401 (k) loans. If they do, they also have some control over which rules apply to the refund.
According to Michelle Smalenberger, CFP, “Your employer may refuse to allow you to contribute while paying off a loan.” Smalenberger is the co-founder of Financial Design Study, a financial planning and wealth management company that pays only fees. “When an employer chooses which plan it will offer or make available to its employees, it has to choose which provisions it will allow.
“If you can’t contribute while you pay, remember that your employer is giving you a benefit by allowing the plan to borrow in the first place,” adds Smalenberger.
And if you can’t make contributions while you pay off your loan, keep in mind that more of your paycheck will go toward income taxes until you resume contributions.
If your employer allows plan loans, the most you can borrow is $ 50,000 or half the present value of your vested account balance, less existing plan loans. You must repay the loan within five years. And taking a loan puts you at risk of facing the obligation to repay it within a narrow time limit, usually 60 days or less, if you are fired or resigned.
It’s also important to know about another way to get money from a 401 (k), namely a hardship withdrawal. Do not confuse them, as this type of withdrawal is not a loan; permanently reduces your account balance. If you do one under certain circumstances, you may not be charged a penalty, although you may owe income tax. If your employer wishes, they can also refuse to allow you to contribute to their account for at least the next six months after a hardship retirement.
The bottom line
When it comes to 401 (k) plans, understanding the rules can be challenging. That’s why it’s important to do your research to find out, so your employer doesn’t take advantage of you and incur unexpected taxes or penalties.