401(k) Rollover Process Can Be Misleading, Report Says

Photodisc/Thinkstock(WASHINGTON) — A report released Wednesday shows workers separating from employers have to navigate an “inefficient rollover process” and “misleading statements” from 401(k) plan service providers regarding rollover IRAs.

For the study, the U.S. Government Accountability Office called 30 call center representatives representing firms administering at least 34 percent of IRA assets at the end of the first quarter of 2011.

When employees leave companies that sponsor 401(k) plans, there are several options available, such as leaving funds with your employer, cashing it out, rolling funds to the new employer’s plan, or rolling the funds into an IRA, or individual retirement account. With an IRA, individuals can make tax-deductible contributions. After age 59½, when individuals are more likely to be retired and in a lower tax bracket, the accounts are generally subject to income tax.

The GAO said the current rollover process of individuals who are leaving a company and have a 401(k) favors IRAs.

The agency found in its investigation that seven of 30 call center representatives said their IRAs were “free” or had no fees with a minimum balance, “without clearly explaining that investment, transaction, and other fees could still apply, depending on investment decisions,” the report said.

“GAO found that service providers’ call center representatives encouraged rolling 401(k) plan savings into an IRA even with only minimal knowledge of a caller’s financial situation,” the report stated.

The agency encourages employers and the IRS, which enforces IRA requirements, to improve the rollover process for 401(k) plan participants.

“Currently, plans may include waiting periods before processing a new employee’s rollover and have long and complex processes for verifying the tax-qualified status of the savings to be rolled over,” the GAO reported. An example of this is the waiting period to roll in an old 401(k) that some employees face when joining a new company.

The GAO said these waiting periods are at the discretion of the plan and can last weeks or months.

“Treasury and IRS officials said that while plans see the delays as an administrative necessity, the delays create uncertainty for participants and complicate the rollover process,” the GAO report stated.

The Internal Revenue Code imposes an additional tax of 10 percent — in addition to ordinary income tax — on cash-outs made from qualified retirement plans, including 401(k) plans and IRAs, before a participant reaches age 59½. The GAO said this was “in order to discourage the use of plan funds for purposes other than retirement and ensure that the favorable tax treatment for plan funds is limited to those that are, in fact, used to provide retirement income.”

As employers have shifted over the last three decades to defined contribution plans after previously offering defined benefit plans like pensions, 401(k) plans are the predominant type of defined contribution plan in the U.S., the GAO said.

In 2010, employers sponsored more than 510,000 401(k) plans for over 60 million workers, according to the U.S. Department of Labor Employee Benefits Security Administration. Those assets totaled $3.1 trillion.

Participants in 401(k) plans are typically allowed to specify the size of their contributions and direct those of their employer to investment options, including mutual funds, target date funds, money market funds or company stock.

According to the Investment Company Institute, IRA assets were $5.1 trillion by mid-year 2012, accounting for 28 percent of U.S. retirement assets.

“Despite the growth in IRA rollovers, very little is known about how the distribution process of 401(k) plan savings came to be centered on rolling savings into an IRA,” the agency wrote to the Senate. “Our past work has highlighted concern that 401(k) plan participants may be encouraged to roll over plan balances to IRAs without understanding or considering other options.”

Created by the Employee Retirement Income Security Act of 1974, the GAO said IRAs were established for two purposes. First, they provide a way for individuals not covered by a pension plan to save for retirement. Second, the GAO said they give retiring workers or those changing jobs “a way to preserve assets from employer-sponsored retirement plans by allowing them to roll over, or transfer, plan balances into IRAs.”

The Taxpayer Relief Act of 1997 created the Roth IRA, which allows individuals to make contributions that are not tax-deductible. After five years, distributions made after age 59½ are not subject to income tax — beyond what was already paid on contributions, the GAO said.

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