Tom Werner | Digital Vision | Getty Images
If you left behind a small 401(k) plan account at a previous job, your previous employer likely moved those funds out of the plan. Experts say the move could hurt your retirement savings in the long run.
Current law allows employers to “force” 401(k) accounts worth $5,000 or less if the owners leave the company, perhaps for another job or due to a layoff. Smaller balances, under $1,000, can be cashed out, while the remainder can be transferred to an individual retirement account.
Experts say employers don't have to do this.
They can choose to keep small balances in the plan; However, most of them do not. To that point, 72% of 401(k) plans don't maintain balances of $5,000 or less once a worker leaves, according to a study by the American Plan Care Council.
Only 7.5% of plans retain legacy accounts regardless of size, according to PSCA data.
More personal finance:
More retirement savers are borrowing from their 401(k) plans
Annuity sales are on track for a record year. What to know before buying
In your 40s, you still need a long-term approach to retirement savings
As more companies have chosen to automatically enroll new employees in their workplace 401(k), these plans have generally accumulated more small accounts. Additionally, thousands of workers may have left behind small balances in the era of the COVID-19 pandemic. In 2022, a record number of workers left their jobs during the “Great Resignation.”
Businesses typically cash out balances of less than $1,000, meaning account holders get a check, less any income tax and Tax penalties The due. Accounts between $1,000 and $5,000 are generally rolled over into an IRA.
A recent law, Secure 2.0, raised that cap from $5,000 to $7,000 in 2024. That means more small balances could be rolled out starting next year. However, this is not automatic, as employers must update their plan rules accordingly.
Companies have an incentive to do this. First, having many small balances can make managing the plan more difficult, as companies must issue notices to a larger number of people.
Small balances can also lead to higher fees, said Ellen Lander, founder of Renaissance Benefit Advisors Group. Bookkeepers — companies that track account holders' savings, investments and other metrics — often charge fees based on the average 401(k) plan balance. A smaller average balance generally results in higher fees, Lander said.
However, there is a tension here. Investors may be better off keeping their money in a 401(k) plan.
If extended, 401(k) assets are often initially held in cash-like investments such as money market funds or certificates of deposit, until investors decide to invest those assets differently. There, they earn relatively little interest while also cutting fees.
Additionally, those who take cash generally owe tax penalties if they are under 59 years of age. Their money is taken from the tax-advantaged pension scheme, affecting their future retirement savings.
But there's good news: Companies must issue notices to workers before charging a microcredit. This means workers can take action before this happens.
Lander said the account holders “have to do something” with the money.
“If a participant already has an IRA, the smartest thing is to take that balance and roll it over to an existing IRA or roll it over to the new employer's 401(k),” Lander added.
Don't miss these stories from CNBC PRO:
“Infuriatingly humble alcohol fanatic. Unapologetic beer practitioner. Analyst.”