What to Do with a Terminated Employee’s 401(k)

You let an employee go, but they left their 401(k) account behind. What are you going to do? This happens sometimes. Fortunately, you do have options. Your plan document will typically detail the processes you should take, but making the right choice can be important.

For starters, you can allow the terminated employee to remain a plan participant. Another option is to force them out and roll their funds over into an Individual Retirement Account, (IRA). Not sure which option is best? We’ll explore each of these so you can make an informed decision.

Key Takeaways:

• You can allow your employee to remain a participant.
• You must provide your terminated employee with a written notice.
• You have the option to force your terminated employee out of the plan.

Let the terminated employee continue as a participant:

Some employers may decide to allow former employees to stay on as plan participants. Former employees who are plan participants won’t be able to add money to their accounts. However, they can continue to manage it and watch their funds mature.

You may want to consider the associated costs of letting the participant remain. Some plan providers base their fees on factors such as the number of participants and total plan assets—amounts contributed by the employer, the employee, and investments.

Give the plan participant a written notice: The IRS requires employers to give notice to plan participants within 90-180 days after the participant stops working for the company. This notice must detail the plan participant’s right to delay receiving their total account balance or request a distribution. It must also explain the drawbacks of withdrawing their funds now instead of waiting until retirement.

The notice given to former employees must contain enough information for them to understand their rights regarding their benefits as well as how to apply for them. The document should include:

• The available benefits
• When benefits will or might be dispersed
• How to apply for benefits

Force the plan participant out:

After providing your former employee with the appropriate notice, you can force terminated employees out of your company’s retirement plan and automatically enroll their funds into an IRA. Most plans have a cash-out threshold of $1,000 whereby the plan may distribute the amount directly to the terminated plan participant without their consent. This transfer is not taxable but is reported to the IRS.

Conclusion:

When you terminate an employee who is also a 401(k) plan participant, you have options. If the cons outweigh the pros of allowing them to stay on as a participant, you can force them out.