Understanding Your Workplace Retirement Plan Or 401(k) Status—Are You Taking Advantage Of All You Can Do?

Founder/CEO of Next Generation Trust Company, a trust company specializing in custodial & administrative services for Self-Directed IRAs.

In the past, people worked for decades for the same company and received a pension when they retired.

Today, with traditional pension plans disappearing, many companies offer qualified retirement plans to eligible employees; the most common one in the for-profit sector is the 401(k) plan. It is a tax-advantaged defined contribution plan in which participants elect a percentage of their salary to be deferred and deposited into the plan. In some cases, employers may choose to make matching contributions.

However, with the Great Resignation underway, and greater job mobility during the past 20 to 30 years, employees are no longer spending decades at one employer. And when they leave, they may inadvertently leave their 401(k) behind.

The 401(k) Plan: Active Participant Vs. Nonactive Participant

The IRS defines an active participant of a 401(k) plan as an individual who is employed during the year in question and is eligible to participate in the plan even if that person elects not to make contributions.

An inactive participant is an employee who used to participate in the plan, and therefore has an account under the plan, but is no longer eligible to participate. This is usually due to changing employers.

Finding An Old 401(k)

It is your responsibility as the participant of the plan to communicate to your plan sponsor what you wish to do with your old 401(k) account. However, you may not realize there are options available to you—and there’s no reason to abandon the plan.

You should be able to reach out to your former employer to inquire about who the plan administrator is for any of your old 401(k) plans. Once you determine who the plan administrator is, you can reach out to them directly and inquire about your options.

In most cases, you would have the option to distribute the account to yourself personally, which may result in taxes/fees if you are not of retirement age—or you can roll the funds into a new plan, like an IRA or another workplace retirement plan.

Note that if you wish to roll any funds into a self-directed IRA, they must be liquid first; self-directed IRAs cannot directly hold publicly traded investments.

Rollover Options—Direct And Indirect

A direct rollover happens between the two accounts (directly from one plan administrator to another) without going to the account owner first (you).

In an indirect rollover, the funds from the original 401(k) are fully distributed to you (usually in the form of a check mailed). You can then redeposit them into another tax-advantaged retirement plan (either another workplace plan or an IRA). This must happen within 60 days to avoid incurring taxes and penalties on the distribution.

Most 401(k) distributions are eligible for rollover, but there are exceptions such as required minimum distributions (RMDs) and hardship distributions. The IRS offers guidance here.

In-Service Withdrawals

In-service withdrawals are distributions from a workplace retirement plan while you are still working at the same company. These are permitted in some but not all 401(k) plans and should be confirmed with your current plan sponsor. Some limitations and benefits to in-service withdrawals are as follows:

• If you are under age 59 ½, the funds for in-service withdrawals are limited to those from employer contributions, not the pre-tax salary deferrals. Once you are 59 ½ or older, this rule no longer applies.

• Effective at age 59 ½, there are no tax penalties on the distribution.

• Penalties are waived for withdrawals up to $10,000 to purchase a first home or for proven financial hardship.

• Employees may be permitted to take in-service withdrawals to invest funds outside of the employer-sponsored plan. For example, the money may go into a self-directed IRA or 401(k), in which the account owner has control over the types of investments in that account.

Can a 401(k) be self-directed?

It depends. Typically, 401(k) plans are invested in stocks, bonds, mutual funds and cash. These investments are chosen by the plan administrator. However, certain plans may allow participants to self-direct their accounts and include alternative assets within their 401(k). These are still employer-sponsored plans and are managed by the plan administrator.

In most cases, individuals will take liquid funds from an old 401(k) and roll them over to a self-directed IRA, which affords them more freedom of choice when it comes to investing in alternative assets.

Through self-directing and choosing your own investments, you can build a more diverse retirement portfolio, hedge against stock market volatility and gain better control over your investment returns.

Self-directed retirement plans enable investors to include alternative assets within their plan, such as real estate, precious metals, private equity, cryptocurrency, hedge funds, notes/loans and much more.

Furthermore, business owners who prefer to self-direct their retirement portfolios may open a solo 401(k) plan. If you are a business owner, you can also self-direct a SEP IRA or a SIMPLE IRA, as well as self-direct a portion of another qualified plan. This affords business owners higher contribution limits than Traditional or Roth IRAs, which can typically only deposit $6,000 of personal contributions per calendar year (or $7,000 if you are over 50).

Self-directed 401(k) plans (also known as solo 401(k) plans) and self-directed IRAs must be opened with a custodian/administrator that specializes in holding alternative assets. If you are looking at this retirement wealth-building strategy, be sure to vet the administrators and custodians as carefully as you would research any investment.

The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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