New Law Affects 401(k) Accounts

By Paula Burkes Erickson, Business Writer, The Oklahoman - March 2005

Gay Jenson recently received a notice from Integris Health, giving her a deadline to roll over her 401(k) account to another qualified retirement plan — or be issued a check for the balance, less about 40 percent in income taxes and early withdrawal penalties

It’s been nine years since she worked there.

"When I changed jobs, I thought I'd completed the necessary paperwork to roll it over," Jenson said. "Then when I began receiving quarterly statements from the financial institution that had my account, I just ignored them. I didn't plan on cashing it out anyway, so it didn't matter to me where it was."

But Jenson, who worked at Integris for about 16 months, cared when she received the notice about a possible forced distribution. To meet the deadline to transfer the money, she rushed to complete paperwork with Integris and her brokerage firm, including presenting a copy of her marriage license to show her legal name change.

"It wasn't that much money — $600 something dollars — but I didn't want most of it to go down the drain," Jenson said.

If checks are issued, former employers automatically withhold 20 percent to apply to taxes due. Any ex-employee who cashes a check, rather than rolling it into an individual retirement account or another qualified retirement plan, must pay income tax on the money, plus an additional 10 percent early withdrawal tax penalty if they are younger than 59 ½.

But former employees of many companies may not have to decide whether to cash out or let the money remain behind when they move to another employer.

A new law — which takes effect Monday — requires employers to automatically roll 401(k) accounts with balances of $1,000 to $5,000 into "safe harbor" IRAs — unless the employee elects a distribution or transfer. Countless retirement savings accounts of $5,000 and smaller of previous employees are being dumped by their former employers to cut administrative costs.

The new law, to encourage retirement savings, prohibits employers from cashing out former employees' 401(k) accounts unless they're less than $1,000. The measure was signed by President Bush in June 2001 as part of the Economic Growth and Relief Reconciliation Act and is being administered by the U.S. Labor Department.

Studies show people change jobs every 3 ½ years and leave low balances in their 401(k) plans. The IRS estimates about 140,000 low balance accounts per year are being automatically cashed out.

According to a 2003 study by Illinois-based Hewitt Associates consulting firm, more than 70 percent of workers who change jobs withdraw their 401(k) dollars to spend the money. Of the roughly 31 percent of workers who participate in that type of retirement plan, 45 percent have balances less than $10,000, the Employee Benefit Research Institute of Washington has found.

"If their accounts are small, many people see them as a panacea to solve any current financial problems they might have," said Reginald Bowser, president of Charlotte, N.C.-based RolloverSystems, Inc.

To make it easier to continue saving, RolloverSystems automates the transfer of retirement accounts for individuals, employers, financial brokers and advisors.

Instead of a lengthy and confusing paperwork process that can take six to eight weeks, the company offers a Web-based electronic form that takes an average of 20 minutes to complete. Consumers can compare offers from nine different IRA providers, including Fidelity Investments, Charles Schwab & Co. and JP Morgan Chase, then be matched with an individual from the institution they choose to guide them, by phone, through the rollover process.

Under the new law, the low-balance accounts of employees who fail to elect a distribution or transfer will be rolled into money market or certificate of deposit based IRAs in their names.

Such accounts, which protect the principal, are the only way a trustee of a plan can relieve themselves of the fiduciary risk, said Ellen Fleming, senior vice president and trust officer at Bank of Oklahoma, which manages about 400 retirement plans, including 45,000 participants, in Oklahoma, Texas, New Mexico, Colorado and Arkansas.

"If you put the money in a stock fund on behalf of somebody, you may be taking more of a risk than they want," Fleming said. "The important thing is the value is stable when a participant is located.

"It's as much a courtesy service as anything. No financial institutions are getting rich because, until the accounts are claimed, no contributions are being made."

Meanwhile, the new law allows plan sponsors to reduce costs by moving low balance accounts out of their plan.

Annual maintenance fees for employers can range from $25 to $75, said Shannon Edwards of Tristar Pension LLC, an Oklahoma City company that administers 401(k)s for about 250 employers in Oklahoma and Dallas.

To comply with the law, most of Edwards' clients with 20 or fewer workers are lowering their threshold for automatic distributions from $5,000 to $1,000, Edwards said. Those with more employees are adopting automatic rollovers.

Meanwhile, many participants remain lazy about electing a rollover or distribution, Edwards said.

"A lot of people just don't take action," she said. "They either don't read the paperwork or think it's junk mail."

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