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7 Obstacles to Rolling an Old 401(k) into a New One

Emily Brandon

When you leave a job, you have four options for your 401(k) plan balance: leave the money in your old 401(k) plan, move it to your new employer's 401(k) plan, roll it over to an IRA, or cash out the 401(k) balance. The last option will trigger income tax, and if you are under age 55 when you leave the job, an early withdrawal penalty. However, a recent U.S. Government Accountability Office report found that many workers are discouraged from both leaving money in the old 401(k) plan and rolling it over into their new employer's 401(k) plan. Many departing employees are also aggressively marketed IRAs, and actively persuaded to leave the 401(k) system.

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"Participants can be easily steered towards IRAs given the number of administrative obstacles and disincentives to staying in the plan environment and the pervasive marketing of IRAs by 401(k) service providers and IRA providers generally," according to the GAO report. "Rolling over to an IRA can be a reasonable choice for many participants and, given the amount of money in IRAs, many individuals and former 401(k) plan participants appear satisfied with that option. But other options, such as staying in their current plan or rolling over into their new employers' plans, may also be viable alternatives and could even be better options depending on an individual's unique circumstances." Here's why it's difficult to keep your money in the 401(k) system:

Disincentives to stay in your old 401(k) plan. Plan administrators are not always required to allow former employees to leave funds in the 401(k) plan if the balance is less than $5,000 or if the participant is over age 62 or the normal retirement age. Some plans automatically distribute 401(k) balances under $5,000 to departing employees. Roughly 60 percent of plans are ambivalent about or even averse to keeping former employees in the plan, according to the GAO analysis of surveys of plan sponsors and asset managers. Plan sponsors who do not want former employees to leave money in their plans often cite the administrative burdens, costs, legal liability and not wanting the fiduciary duty to former employees. Some plans even charge higher or additional fees to former employees, restrict their ability to manage their savings or take a loan from the plan and limit distribution options. Perhaps because of these restrictions, most people eventually withdraw their money from the old 401(k) plan. Among retirement account participants age 60 and over who left their jobs in 2004, about 50 percent of their plan savings remained in the employer plan 1 year after separating, but only about 20 percent of their 401(k) savings was still in the plan 5 years after leaving the job, according to industry data obtained by GAO.

401(k) rollover waiting periods. 401(k) plans are not required to accept rollovers, so workers must contact the new plan's administrator to determine if a rollover into the new 401(k) plan will be possible. And even if a rollover is allowed, 401(k) plans may have waiting periods before processing a new employee's rollover, which vary by plan and can last weeks or months. The delay could leave participants uncertain about the status of their retirement savings.

Complex 401(k) verifications. 401(k) plans may require a lengthy verification process for rollover funds to ensure they are tax-qualified. The plan sponsor might request verification forms from the previous plan that individuals must get their former employer to complete and return. One plan sponsor told the GAO that only 10 to 15 percent of participants who leave the plan move their savings to a new employer's plan because of barriers in the process, including many paper forms and the involvement of both plan administrators. "That difficulty may discourage participants from keeping their savings in the plan environment, which generally has lower fees, better comparative information, and ERISA plan fiduciaries required to select and monitor reasonable investment options," GAO found.

[Read: 10 Secrets of Successful Retirement Savers.]

Lengthy paperwork requirements. There is no standardized 401(k) distribution paperwork, and many plans use different distribution forms. GAO reviewed 14 packets of sample distribution materials and found that they ranged from single documents of a few pages to multiple documents exceeding 15 pages in total. And more than half of the packets did not include a distribution request form, when means participants would need to contact their plans or service providers to request the necessary form.

Excessive processing time. 401(k) plans are not required to process distribution requests in a specified time frame. And if the plan participant is requesting that the money be transferred to another service provider, there is little incentive to process these requests expeditiously.

Potential to trigger fees and taxes. Whenever you move money from one retirement account to another, it's best to ask the 401(k) plan sponsor to directly transfer the money to the new financial institution. If the distribution check is made out to the 401(k) participant, 20 percent of the account balance will be withheld for income tax. And if the entire account balance, including the withheld 20 percent, is not deposited into a new retirement account within 60 days, it is considered a withdrawal. The former employee will then become responsible for paying income tax and, if under age 55, a 10 percent early withdrawal penalty on any amount not rolled over. For example, let's say you have $50,000 in your 401(k), and your former employer writes you a check for $40,000. If you only deposit the $40,000 in a new 401(k) or IRA, the $10,000 will be counted as income and taxes and the early withdrawal penalty may be applied.

Pervasive marketing of IRAs. Rollovers are the largest source of contributions to IRAs. Between 1996 and 2008, over 90 percent of traditional IRA deposits came from rollovers primarily from workplace retirement plans, according to the Investment Company Institute. Many 401(k) service providers aggressively market their IRA plans to departing employees. Educational materials given to 401(k) participants often include their firms' IRA products as examples, and call center representatives sometimes get financial incentives when plan participants roll their money over into the company's IRA products, even when they might not serve the participant's best interest.

A GAO investigator phoned 30 401(k) plan service providers, posing as someone about to start a new job and potentially join a new employer's 401(k) plan. Many service provider representatives encouraged him to roll his plan savings to an IRA instead of the new plan without specific knowledge of his financial circumstances (11), brought up the fact that IRAs have more investment options than 401(k) plans (16) and raised doubts about the caller's ability to roll his money over to a new 401(k) plan (12). IRA providers often offer workers assistance with the rollover process and help with the paperwork. Some financial institutions advertise that someone could roll money over to their IRA in 15 minutes or less and even offer sign up bonuses ranging from $50 to $2,500, depending on the individual's amount of savings.

[Read: Smart Strategies for 401(k) Rollovers to IRAs.]

When deciding whether to leave your retirement savings in a former employer's 401(k) plan or roll it over to an IRA or new 401(k) plan it's important to compare all three plans based on their merits, not which requires the least paperwork. Take a look at the investment options and the fees charged in each account, and make a decision based on which account will best meet your long-term retirement investing needs. Although waiting periods and processing time can be a hassle, don't let that jeopardize what will ultimately be best for your retirement security.

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