Understanding 401(k) plan sponsor responsibilities when employees leave a job

Collaborate with your TPA or recordkeeper for help

If your job includes managing your employee benefits and retirement plan, you’re probably familiar with how things work when someone leaves your company. Helping your departing employees understand their options can help you cultivate good will, even after they’ve left. When someone leaves, you’ll communicate details such as accrued time off and how healthcare benefits are affected. It’s just as important for you to explain how leaving affects their retirement plan and what they can do with the money in their 401(k).

Your company’s retirement plan setup determines who’s responsible for notifying exiting employees of their options. Generally, it’s one of three parties:

• Employer—As the employer, you may share the information yourself when employees leave the company.
• TPA—You may want your TPA to be responsible for mailing the necessary information once you’ve notified the TPA of the employee’s status change. 
• Recordkeeper—You may also set your recordkeeper up to handle it. Your recordkeeper can send the departing employee the information once he or she is notified of the status change through email, web portal, or a payroll file.

Support exiting employees with retirement plan transitions  

If you’re responsible for overseeing your company’s retirement plan, then you know the ins and outs of the plan’s rules. That’s especially true if you’re the one communicating the options to an exiting employee. 

Use this checklist to help be sure you cover all the necessary bases:

• Withdrawal forms—Does your plan require departing employees to fill out a withdrawal form? Or are they directed to go to the recordkeeper’s website or call if they want to make a withdrawal? If a form is required, who sends it out?
• Loans—Does your plan offer loans? If so, does the employee have an outstanding loan? If so, does your plan allow terminated employees to continue paying off the loan? Or do they have to pay it back at termination? This affects the amount employees may expect to receive when withdrawing their money. And if they can’t pay it back, they may be in default and face penalties. Make sure the employee understands the impact of the loan.
• Force-outs—What are your plan’s force-out provisions? If the employee’s balance is under a certain amount, how much time does he or she have after the termination date to take a withdrawal before the funds are rolled over to an IRA or paid directly to him or her?
• Waiting period—Does your plan have a waiting period from the date of termination before a withdrawal request can be processed?

Communicate 401(k) options to your exiting employees 

Your role is to make sure your employees are aware of their choices so they can make an informed decision. It’s important for you to clearly communicate the various withdrawal options. 

Option 1: Stay in plan

Your departing employees may be able to keep the money right where it is and have it continue to grow tax deferred, depending on their balance and the plan rules.

Option 2: Move to another employer’s plan 

Employees who choose this option have their money rolled over as a nontaxable event and can keep it growing tax deferred.

Option 3: Roll over to an IRA

This rollover option is also nontaxable and allows employees to keep their money growing tax deferred. You’ll need to check with your plan’s recordkeeper to see if an IRA option is available. If offered, this may be a seamless transaction.

Option 4: Cash out

Cashing out is—and should always be—the option of last resort. Employees who decide to cash out may be assessed an early withdrawal penalty, a 20% mandatory federal tax withholding, and state tax withholding, if applicable. And they’ll have to report the gross withdrawal as income when filing their taxes.

Enhance an employee’s exit with retirement plan support

Departing employees need to understand the options they have for their 401(k) plan to minimize the chance that leaving your company could have a negative impact on their retirement savings. As a plan sponsor, you’re responsible for making sure that someone communicates the choices. You may either do it yourself or have your TPA or recordkeeper handle the communication. One benefit of having your TPA or recordkeeper do it is that they often have tools and resources to help employees decide what’s right for their situation. Making the process easy can build good will and help your company be an employer of choice.

Visit the IRS website² for more information on operating a 401(k) plan.

1 There are advantages and disadvantages to all rollover options. Participants are encouraged to review their options to determine if staying in a retirement plan, rolling over to an IRA, or another option is best for them. 2 irs.gov/retirement-plans/operating-a-401k-plan.