Sudden unemployment is very stressful for you and your family. Your focus is naturally on coping with life today. But if you had retirement benefits with your job, you may need to move quickly to protect their value. After all, you worked hard for this money, and you will need all of it when you retire. Handling these funds properly now will save you time, effort, and probably money. Besides, having your personal business in order may help reduce the anxiety you may feel at this unsettling time.
A basic understanding of your retirement plan and its relationship to your employer is necessary to determine your rights and responsibilities for your plan. Your employer decides the overall plan for your company or group of employees. The retirement plan is a fund separate from the company. Your employer forwards amounts withheld from your paycheck and any company contributions to a plan administrator or trustee. The plan administrator keeps track of all transactions in your account.
Start with collecting complete, up-to-date information about your future benefits. The law requires private-sector employers to provide you with information about your pain. Your company's Summary Plan Document will contain most of the information. In this document there is a description of how your benefits are calculated, when you become vested, when you may receive your benefits and in what form. If you don’t have a Summary Plan Document, ask your benefits office to get you one.
Request in writing your individual benefit statement from the plan administrator. Do not ask your employer for this information. You are entitled to a response within 30 days. The Summary Plan Document tells you what the rules are for everyone in the plan. The individual benefit statement tells you what you have in the plan. Look these over carefully, fitting your own details into the bigger picture, to see what are your personal options.
The two most common types of retirement plans are defined benefit plans and defined contribution plans. You are likely to have one of these plans, although some small employers may offer other types of plans. Defined benefit and defined contribution plans are fundamentally different and your rights on leaving the company are likewise very different. So figure out which kind you have.
Defined Benefit Plans
With a defined benefit plan you are guaranteed a certain amount at retirement. This figure is determined by a formula that takes into consideration your more recent levels of pay and years of service. The formula varies from plan to plan.
The first question to ask is “To what extent am I vested?” Your employer has been making contributions to the plan on your behalf. The plan is likely to have a condition that states those contributions aren’t really yours until you have been employed for a designated number of years.
The only way to get full advantage of this type of plan is to leave it intact until you meet the required retirement age. The plan might allow you to “cash out” but you’ll only be able to take contributions you may have made. You’ll have to leave behind any funds your employer made on your behalf even if you were fully vested. You will be out of the plan completely, with no rights to future benefits.
You may have concerns about the future financial viability of the plan. The Pension Benefit Guarantee Corporation will assume responsibility for funding and payments (up to a certain amount) if your employer fails to meet its obligations under a defined benefit plan.
Defined Contribution Plans
With a defined contribution plan, the employer and usually the employee, make a contribution each pay period to the retirement account. These contributions are based on some percentage of your gross pay. Over time your account grows with these contributions and with any investment income that is earned on the account balance. Since these amounts often change, your future retirement benefits can not be calculated with any certainty. You are not guaranteed a set amount.
The Pension Benefit Guarantee Corporation does not back up this type of retirement plan.
Examples of defined contribution plans include a savings, or thrift plan, a profit-sharing plan, money purchase pension plan, employee stock ownership plan, and a 401(k) plan. The most common of these plans is the 401(k) and the one we will consider here.
Several variations of 401(k) plans exist, but generally the employee’s contribution is made with pretax dollars. These amounts are immediately vested. If the employer makes a contribution to the employee’s account, that amount is also not subject to federal income tax. The vesting of these employer-contributed funds may be based on length of service. The pretax nature of these contributions is key to understanding some of the concerns faced when leaving an employer.
Distribution and Payment Options
When you leave an employer that sponsors your 401(k) plan, you have several options. If the plan allows, you may leave your money in the plan. You may “cash out.” You may be allowed to move your money to a plan at a new employer. Or you may move your money to a Rollover IRA. In some cases a combination of the options may work best for you.
If you feel the company you are leaving is a strong, viable company with a bright future, you may have the option to leave your retirement fund with the company. There are some possible disadvantages to this decision, however. As a nonemployee participant, you may be charged extra administrative fees, and you may not be eligible for any future enhancements to the plan. Another danger to remaining in the plan is that you may simply lose track of the money, especially if you are young or are likely to move frequently. Read over your Summary Plan Document carefully to see what your position will be if you stay with the plan.
You may be tempted to “cash out.” If you have lost your job, you probably will be in tight financial circumstances until you find a new job. You could probably use the money, but this is a very expensive alternative. Remember 401(k) plan money is pretax. So if you take the money for current use, it becomes immediately taxable. The plan administrator will deduct a 10% penalty and 20% federal withholding tax before issuing you a check. Plus, you may have to pay additional federal, state, and local income taxes when you file your tax return. Depending on your tax bracket, you might lose up to 50% of your money, which is a significant loss of retirement funds.
You may take your money out of the plan. By properly moving the money to a new account you can avoid penalties and taxes. If your employer is closing or the plan is terminating, you may have to move your funds. If your account balance is less than$5,000, you may be forced to leave the plan even if the plan continues to operate.
There may be other reasons for transfer-ring retirement funds. Your employer may be in poor financial condition and you don’t expect to gain anything by staying. You may not be happy with the plan and think you can do better. Or a new employer may accept money from a previous plan into your new plan.
Transferring Retirement Funds
It is critical to follow the proper steps when moving your retirement funds to avoid penalties and taxes. Unless you’ve found a new job with a 401(k) plan that will accept a transfer right away, you should arrange a Rollover IRA. The first step in this process is finding a traditional IRA into which you want your funds transferred. If you rollover your retirement funds to a Roth IRA, you will have to pay taxes in the current year. Be sure to choose a traditional IRA where you will pay taxes only as you withdraw the money when you retire.
Choosing a Rollover IRA investment account is a difficult decision. There are lots of IRA investment choices on the market. If you are uncertain as to the best alternative for you, check with a credible financial advisor or have the funds transferred to a Rollover IRA account that is insured and liquid. You can move your 401(k) money to this type of account while you learn more about your investment options. You can then move your Rollover IRA into another Rollover IRA with different investment benefits in the near future.
Use extreme caution if you encounter an investment called a Rollover Annuity. This is a fundamentally different investment from a Rollover IRA. An annuity is an insurance company product that, for an initial investment in a contract, promises to make set periodic payments to you within a given time frame. There are lots of variations on this theme but the one common condition with annuities is that once you’ve invested in one you can’t change the contract. You may have a narrow range of investment choices within the annuity contract, but the contract is permanent within its terms. If you become dissatisfied with the annuity’s performance, you can’t move your money to another investment.
Once you decide where you want to move your money, open an account that is specifically a Rollover IRA. Make arrangements for your current 401(k) plan trustee to send the funds directly to your new Rollover IRA account custodian. Both parties are familiar with this process. They will have the right forms on hand. Proper handling of your funds at this point is most important to avoid taxes and penalties. Never let your IRA account funds come to you directly, even as a check.
Do not delay taking action. You likely will have a time frame in which this transfer must take place, often 60 days from leaving your job. Otherwise, a check may be sent directly to you, minus the penalty and taxes. So be sure you don’t put off looking at your information and making a decision. Also, be cautious about mixing this money with any other IRA accounts you may have. Laws are changing right now that make co-mingling of funds less of a problem. But make sure you know it won’t cause you any difficulty in the future, especially if you wish to move this money into another account later. And keeping funds separated makes it much easier to track returns and distributions.
Checking Retirement Benefits
|1. I have located my Summary Plan Document.|
If to do, request SPD from employee benefits office.
|2. I have requested my up-to-date individual benefits statement from the plan administrator.||Yes||To do|
|3. What kind of plan do I have?||Defined benefit (Go to #4)||Defined contribution (Go to #6)|
|Defined Benefit Plan|
|4. To what extent am I vested?|
|5. Complete information required to stay in the plan.||Yes||To do|
|Defined Contribution Plan|
|6. Will I be leaving the plan?||Yes (Proceed to #7)||No|
|7. How soon must I act?|
|8. Have I investigated Rollover IRA investment choices?||Yes||To do|
|9. Have I arranged for the transfer of my funds to my Rollover IRA?||Yes||To do|
Hoffman, Ellen. Protecting Your Retirement Benefits after the Pink Slip. BusinessWeek online, February 8, 2001.
Rollover IRAs at Fidelity Investments
Pension and Health Care Coverage…Questions and Answers for Dislocated Workers, U.S. Department of Labor.
Fundamentals of Employee Benefit Programs (2002). Washington, D.C., Employee Benefit Research Institute.
Prepared by Sarah Siegel, former extension agent, Marilyn Furry, associate professor of agricultural and extension education, and Natalie M. Ferry, coordinator of special program initiatives for Penn State Extension and Outreach.