Until 2005, employers routinely cashed out small 401(k) plan accounts when workers quit. Previous law allowed them to sell 401(k) assets and send checks to workers who had less than $5,000 in their accounts, forcing the recipients to figure out on their own how to roll over those amounts into IRAs to avoid the extensive taxes and penalties that would otherwise apply.
Current law, however, only allows that option for workers with less than $1,000 in their accounts. For those with between $1,000 and $5,000, employers have to go to the trouble of setting up an IRA for their former employees.
That's enough of a hassle that many employers didn't bother doing it. But as administrative costs of managing 401(k)s have risen, forcibly pushing former workers into IRAs has gotten more popular.
Why Is That Bad?
In general, rolling over an old 401(k) to an IRA can be the smartest move you can make. That's because it gives you access to a wider range of investment options that are often less expensive. It also helps you avoid the tax hit of just depositing old 401(k) money into your regular bank account.
But for those with tiny account balances, those low-cost options are a lot harder to find. Without the clout that a large 401(k) plan brings, you won't get the same lucrative deals that many major employers can get, including low-cost institutional mutual funds and other favorable investments.
Two Ways to Deal With Being Dumped
If your former employer boots you out of your 401(k), realize that you have options.
If the IRA that your former employer sets up for you isn't what you want, you have the right to transfer that money to the provider of your choice. That way, you can pick a lower-cost IRA that meets your needs.
Alternatively, if you have a 401(k) account with your current employer, you can roll the IRA money into that account. That strategy works best if you like your current plan's investment options better than what you have access to elsewhere.