If your business offers a 401(k) plan, it’s important for it to accept direct 401(k) rollovers so your employees can transfer assets and secure their savings. They must also understand how direct 401(k) rollovers work and how they can move their retirement savings into your company’s plan. Clear information and ongoing communication can help your employees successfully navigate the process so they can accurately complete a rollover without any tax implications. Additionally, 401(k) rollovers help increase assets under management, which has advantages for your plan.
What is a direct 401(k) rollover?
A direct rollover moves retirement assets from one qualified retirement plan to another while maintaining the tax-deferred status of the assets. An employee’s previous 401(k) plan administrator (or IRA custodian) cuts a check or wire transfers funds directly into your company’s 401(k) plan. Since the employee never takes possession of the assets, there is no mandatory 20% federal tax withholding or early withdrawal penalty.
A direct rollover helps maintain the tax-deferred status of retirement savings while consolidating accounts, making it easier for your employees to manage their investments. For business owners, providing guidance on rolling over a 401(k) and offering comprehensive retirement planning options also helps enhance employee satisfaction.
Why employees cash out 401(k)s when changing jobs and how you can help them hold on to their savings
Complex rollover procedures and a lack of guidance causes many employees to take the path of least resistance and prematurely cash out their 401(k) when changing jobs. A recent study found that more than 41% of employees who leave a job cash out their 401(k).1
You can help employees hold on to their savings by clearly communicating the disadvantages of cashing out retirement plans early, which include:
- Mandatory 20% federal income tax withholding
- 10% early withdrawal penalty – taking money out before the age of 59½ comes with an additional 10% tax penalty
- Income tax – the amount withdrawn is added to taxable income for the year and could push an employee into a higher tax bracket with a larger tax bill
- The amount withheld may not be enough to cover an employee’s full tax liability and the remainder must be paid when filing tax returns
You can also help employees calculate the net amount of a distribution before they cash out by providing information on what they’ll pocket after taxes (examples, tables, calculator, etc.). Understanding the significant tax penalties may help employees reconsider cashing out their savings and the impact it can have on their financial security in retirement.
Example scenarios of a cash out vs. a direct rollover
Cash out example
Dave, age 42, leaves his California job and decides to cash out his $100,000 401(k) savings to pay off bills and loans. His net proceeds will be reduced by these taxes and penalties:
- 20% mandatory federal withholding
- 1-13.3% CA tax for distributions as regular income
- 10% IRS tax penalty for withdrawing before age 59 ½
That means that 31% or more of the $100,000 distribution will be applied to taxes and penalties.
Direct rollover example
Audrey, age 35, leaves her California job and decides to roll over her $100,000 savings into a new 401(k) plan with her employer. Her savings are not impacted by taxes or penalties and continue to grow in her account. When returns from investments – such as mutual funds, value funds and fixed interest accounts – are reinvested into the account, they compound each time earnings are paid. While distributions will be taxable in retirement, her account grows more quickly with compound growth. If she waits until after age 59 ½ to take a distribution, there is also no longer a 10% IRS penalty.
What your employees need to know about direct 401(k) rollovers
To initiate a direct rollover, employees need to gather the following information from their existing plan:
- The account number for the retirement plan they want to roll over (e.g., an IRA or previous employer plan).
- The name, address and contact information of the financial institution holding the retirement assets.
Employees also need the following information about your company’s 401(k) plan:
- The name and address of your company’s 401(k) plan
- The name and contact details for your plan administrator
- Your 401(k) plan account number or identifier
- Types of transfers accepted, including check, wire or another way to send
- Tax information about direct rollovers
Along with these details, you may want to provide clear steps on how to start the 401(k) rollover:
- Contact the previous employer to initiate the rollover process
- Identify any paperwork the previous employer needs, such as a letter of acceptance
- Determine how checks should be made payable – a direct rollover that is payable to the new provider will not have taxes withheld; if the check is payable to the employee, it must be deposited into the new plan within 60 days
- Verify if a rollover request form needs to be completed
Employees can begin investing in a new employer 401(k) plan as soon as they’re eligible. Make sure they know they don’t need to wait for their assets to roll over into the plan.
Benefits of a direct 401(k) rollover
There are several advantages for employees who choose to roll over their 401(k) into another retirement plan. These benefits include the following:
- A direct 401(k) rollover into an employee’s new retirement plan may be less costly because their previous retirement provider may charge additional fees to employees who no longer work there.
- Consolidating retirement plans makes managing them much easier for employees.
- A direct 401(k) rollover into an IRA gives employees the security of keeping their investment indefinitely if they switch jobs because IRAs are individually owned and not employer sponsored.
- A rollover into a Roth IRA provides employees with tax-free withdrawals over the age of 59 ½ as long as the Roth IRA account is held for five years or more. In addition, Roth IRAs are exempt from required minimum distributions, unlike 401(k)s and IRAs.
Risks for employees who leave retirement assets behind
Employees who leave behind retirement assets may have some risks. Foremost, it adds complexity to the management of their investment portfolio.
Secondly, out of sight means out of mind and accounts that are left behind don’t get the attention they need. Employees may not keep their beneficiary designations up-to-date or accurately track their required minimum distributions. Higher fees and fewer investment options may also be at play.
Beginning in 2025, plans will be required to share information with the U.S. Department of Labor to be included in a searchable database mandated by the SECURE Act 2.0. The database will help missing participants and their beneficiaries find accounts or their benefits, along with plan administrator contact information.
Advantages of direct rollovers for employers
There are advantages for your business when employees transfer 401(k) retirement accounts into your company’s 401(k) plan. The total assets under management increase and a larger plan may lead to reduced fees and better pricing from plan providers. Increased assets may also result in the ability to choose different investment share class options or more investment choices, which can benefit all plan participants.
Additionally, when employees consolidate their assets in your company’s plan, it can improve overall plan health. Metrics, like average account balances and participation rates may increase, making the plan more attractive to employees and prospective hires. A well-managed, high-asset 401(k) plan can be an important part of recruiting and retaining top talent. It also demonstrates that you’re committed to your employees’ financial wellness and retirement security.
How ADP retirement planning services can help
If you’re looking to switch 401(k) plan providers, ADP Retirement Services can help. We have the experience and flexibility to help you address your retirement plan goals and challenges while making saving for retirement simple and engaging for plan participants. Our retirement plan solutions readily meet the unique needs of your business regardless of how many employees you have.
Our personalized employee experience uses advanced technology and analytics that can help you and your employees make better retirement plan decisions. Plan administrators and participants also have access to a robust resource center with educational content on a variety of financial wellness topics, from how much they should be saving for retirement to paying off student loan debt or saving for a home. Personalized insights and education help employees make better retirement savings decisions.
When your payroll and retirement plan are with ADP, our advanced technology seamlessly integrates data and information across both platforms to help simplify plan administration and reduce compliance risk. We transmit data in real time and check for discrepancies, as well as transfer funds quickly and generate trades for your plan participants. Your employee data remains secure within ADP’s ecosystem and is not transmitted to third parties.
Contact an ADP retirement services specialist now to learn more at 844-912-3742.
Frequently asked questions about 401(k) rollovers
What type of funds can employees roll over into their retirement 401(k) plan?
Savings from one of the following plan types may be rolled over:
- Profit-sharing
- 401(k), 403(b), 457(b), money purchase and defined benefit pension plans
- Traditional IRA, SEP IRA or a SIMPLE IRA if it’s existed for at leasttwoyears
This IRA Rollover Chart provides a snapshot of what types of funds may be rolled into a 401(k) plan.
Can an employee roll over a Roth IRA?
No, a Roth IRA cannot be rolled into your company’s retirement plan account.
Why don’t some 401(k) retirement plans accept direct rollovers?
There are a few reasons why some plans may not accept direct 401(k) rollovers, including a preference by some plan administrators to keep the money in the plan to benefit from mutual fund fees that accrue. Some plan sponsors may also temporarily prohibit employees from making further contributions if they withdraw funds before leaving the company. After an employee leaves a company, however, the U.S. Department of Labor requires plan administrators to send requested rollover paperwork as soon as possible.
What other options do employees have for transferring retirement assets when they leave a job to keep their savings growing tax free?
Termination of employment or another “distributable event” must happen before employees can move assets. Then, they have the following three options in addition to a direct rollover:
- Leave it in their old plan – For larger balances, employees may want to stay in the plan for the investment options or low fees. If employees have a small balance, this might not be an option because some plans have a force-out provision. An employer can involuntarily roll an employee’s savings into an IRA on their behalf.
- Roll it into an IRA – Employees may choose this option if they want more investment options or if the IRA has lower fees. An IRA also has the advantage of being an individual account through a broker or bank, so it isn’t affected by job changes.
- Do an indirect rollover – Employees may transfer funds from one account to another themselves by taking out the funds and redepositing them into another retirement account within 60 days to avoid taxes and penalties. There is a mandatory 20% federal withholding; state taxes may also apply.
Generally, how long does the direct rollover process take?
It can take 30 days or longer to fully complete a direct rollover from one account to a new 401(k) plan account. Processing times for each plan can take more than a week, and then if a check is cut, there’s mail time on top of that.
1 Marketing Science, Cashing Out Retirement Savings at Job Separation, November 2022
ADP, Inc. owns and operates the ADP.com website. Unless otherwise disclosed or agreed to in writing with a client, ADP, Inc. and its affiliates (ADP) do not endorse or recommend specific investment companies or products. Please consult with your own advisors for such advice. Investment options are available through the applicable entity(ies) for each retirement product. Investment options in the “ADP Direct Products” are available through either ADP Broker-Dealer, Inc. (ADP BD), Member FINRA, an affiliate of ADP, Inc., One ADP Blvd, Roseland, NJ 07068 or (in the case of certain investments) ADP, Inc. Only registered representatives of ADP BD may offer and sell ADP retirement products and services or speak to retirement plan features and/or investment options available in any ADP retirement products.
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