Taking Care of Mom and Dad: How 401(k) Money Gets "Lost"

If either of your parents has had several jobs (or just more than one) since the late 1970s or early 1980s, there's a fair chance that they have retirement money in several accounts in several places.

More often than you might expect, older people will simply forget where they have retirement money. This is especially true if they had a job for just a year or two...or if they worked at a company that went through corporate ownership changes (mergers, acquisitions, divestitures, etc.).

When your parents leave a job, it's not always clear what happens to 401(k) money. Basically, they have four choices:

• leave the money where it is;
• move the money to a 401(k) at the next job;
• put the money in "storage" in an Individual Retirement Account (IRA) or similar account; or
• take the cash.

If your dad accumulated more than $5,000 in a 401(k), his ex-employer has to allow him to keep the money in that plan until he retires or reaches 70½. Although your dad can't put any more money into that 401(k), his money continues to grow without paying taxes.

In some cases, especially if the money is well invested, it makes sense to leave it in place. In other cases, usually because your dad is intimidated by money management issues, it's simply easiest to leave the money where it is. Although your dad's old company isn't supposed to give him advice about what to do with the money, human resources may encourage workers to leave their money in place. (The larger the plan, the more attention the company will get from brokers and plan administrators.)

Of course, your parents may be able to get better investment options by moving their money to their new employer's plan.

Most employers will allow new employers to move money from their old plans into the new company's 401(k) immediately. The best way to move the money is through a tax-free transfer -- called a rollover. This transfer can happen directly between the plan administrators (strictly speaking, the IRS doesn't consider this version a rollover, though everyone else calls it that) or it can involve a distribution to your parents that they reinvest within 60 days.

Occasionally, there's an error in the transfer of the money. The problem may be that the money is credited to the wrong account within a benefit plan; this problem is often self-correcting, if the plan administrator is competent and paying attention.

More often, if the transfer took the form of a distribution to your parents, they may have forgotten to reinvest it with 60 days. This can cause problems -- especially if your parents ended up spending the money or putting it in an ordinary savings account. They're going to owe tax on the money.

If a new employer's plan won't accept money from another plan or won't accept it right away...or if your parents don't have a new employer...they can move their money to an IRA.

In most cases, your parents should keep this transferred money in a new, separate IRA set up specifically for this purpose. This avoids mixing the 401(k) money with any other, existing IRAs and allows it to be moved into another 401(k) at some future date.

If your parents mix their old 401(k) with IRA funds, the funds can't be separated. This means they give up any benefits that 401(k) and other retirement funds have over IRAs.

Even though it's a good idea to keep retirement moneys from different jobs separate, the idea means -- as you might guess -- that some people end up with small amounts of money deposited in too many different accounts.

This tendency toward multiple accounts is encouraged by the fact that most banks, brokerage firms and mutual funds are eager to help people set up numerous accounts. Even if the numerous accounts aren't really what the people need.

While this pushing of retirement accounts and selling of rollover kits isn't malfeasance on an Enron-like scale, it can work against your parents' best interest. They can end up with three, four...six or eight retirement accounts and a few thousand dollars in each. This makes a single account easier to forget. And it makes it more difficult for your parents to notice a misplaced transfer or other such mistake.

Most important: Having many accounts is expensive. Each account has its own fees, which compound over time. Combining all of your parents' accounts into one eliminates these redundant fees.

If your parents move their retirement money, it's best that they avoid taking the money from their old 401(k) in the form of a check.

If your mom has $10,000 in a 401(k) and she asks her former employer for a check, she'll only get $8,000 ($10,000 less 20 percent withholding, or $2,000). She'll have to come up with $2,000 out of her pocket to put in her new plan -- and she'll have to do it within 60 days. Even if she can scrape together the $2,000, she'll have to wait until her next tax refund to get the $2,000 withholding back from the IRS. If she only puts the $8,000 into her new plan, she'll have to pay taxes on $2,000, plus (if she's under 59½ ) an additional 10 percent penalty ($200) for early withdrawal of retirement money.

The best person to help your mom with a direct transfer is the administrator of her new employer's 401(k) plan or the person at her bank or brokerage firm where she set up an IRA to receive the money.