How do you close out your 401k

If you decide your 401(k) plan no longer suits your business, consult with your financial institution or benefits practitioner to determine if another type of retirement plan might be a better match. As a general rule, you can terminate your 401(k) plan at your discretion.

Full termination

A plan termination requires more than deciding to discontinue the plan

The IRS considers a 401(k) plan terminated only if:

• The date of termination is established (this can take the form of a plan amendment, board of directors’ resolution, or complete discontinuance of contributions);
• The benefits and liabilities under the plan are determined as of the date of plan termination; and
• All assets are distributed as soon as administratively feasible, generally within one year after the date of plan termination.

A 401(k) plan that has not distributed its assets as soon as administratively feasible is considered an ongoing plan and must continue to meet the qualification requirements, including amending the plan document for law changes. If you maintain another plan, you may have to transfer employees’ elective deferral accounts to the other plan rather than distributing them to employees.

See Terminating a Retirement Plan for the required steps.

Generally, the process of terminating a 401(k) plan includes amending the plan document, distributing all assets, notifying employees, filing a final 5500-series form and possibly filing a Form 5310PDF, Application for Determination for Terminating Plan, to ask the IRS to make a determination on the plan's qualification status at the plan termination date.

Partial termination

Depending on the facts and circumstances, your plan may have a partial termination. This can happen if an action by the employer causes a significant decrease (generally at least 20%) in plan participation. Layoffs, plan amendments, or business reorganizations that cause a decrease in plan participation are counted even if they result from economic circumstances beyond the employer’s control. See the plan termination FAQs for more information.

COVID-19 relief for certain partial terminations: The Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act) changed how plan sponsors determine partial terminations during the pandemic. For a plan year that includes the period beginning on March 13, 2020, and ending on March 31, 2021, a plan will not have a partial termination if the number of active participants covered by the plan on March 31, 2021, is at least 80 percent of the number of active participants covered by the plan on March 13, 2020.

In response to Section 209 of the Relief Act, the IRS released five FAQs to help clarify how partial terminations are determined during any plan year which includes the period beginning on March 13, 2020, and ending on March 31, 2021.

100% vesting

All affected participants become fully vested in their account balances on the date of the full or partial plan termination, regardless of the plan’s vesting schedule.

• Elective deferrals are always 100% vested.
• Full vesting in a plan termination applies to employer nonelective contributions (such as profit-sharing contributions) and to matching contributions.

Full termination - Affected participants are current or former employees who haven’t received full payment of their vested interest by the plan termination date, unless they’ve incurred at least 5 consecutive 1-year breaks in service.

Partial termination - Affected participants are generally any employees who left employment for any reason during the plan year in which the partial termination occurred and who still have an account balance under the plan. Some plans wait until a participant has 5 consecutive 1-year breaks in service before the participant forfeits their nonvested account balance. For these plans, participants who left during the plan year of the partial termination and who have not had 5 consecutive 1-year breaks in service are affected participants. See IRC Section 411(d)(3) and Revenue Ruling 2007-43.

If you leave an employer where you have a 401(k) plan, you might want to close out that 401(k) account. Sometimes you can let the money stay in that old 401(k), but people often want to completely cut their ties with the company and consolidate financial accounts for easier record keeping. You can reduce your liability for taxes and penalties by rolling these accounts into new tax-deferred accounts.

Current Employer

Your options might be limited if you want to close an account with a current employer and you're not 59 1/2 or older. Although some employers' plans allow withdrawals and account closure for any reason, many restrict participants to hardship withdrawals. Your plan might allow a withdrawal and closing of the account only if you face the loss of your home or must pay unexpected medical or funeral expenses.

Lump-Sum Withdrawal

With a previous employer, you can always close a 401(k) plan by requesting a withdrawal of the entire account balance. The plan administrator will sell all of the investments in your account and will issue you a check, closing the account. The plan trustee also will withhold 20 percent of the amount that you withdraw to cover any potential taxes on your withdrawal – possibly more if your state requires withholding. The money you take out will be taxed at your normal rate for income. And if you're younger than 59 1/2, you will pay a 10 percent penalty on this early withdrawal.

60-Day Rollover

You can avoid taxes and penalties by depositing the entire amount that you withdrew into an individual retirement account within 60 days. Keep in mind that you'd also need to deposit an amount equal to what the administrator withheld for taxes; otherwise, that withheld amount would be considered an early withdrawal. You'd be responsible for the taxes on that amount – as well as for the 10 percent penalty if you're not yet 59 1/2 – unless you could make up those funds from other sources.

IRA Rollover

You can close a 401(k) account with a former employer by rolling the funds over to an individual retirement account. You begin this transaction by requesting the trustee of your IRA to contact the trustee of the 401(k) and ask him to sell all of the investments held in the account, and to transfer the cash from the sale to the IRA trustee. In some cases, the trustee may request the transfer of the shares of stocks or mutual funds instead of cash from the sale. Once the 401(k) trustee completes this transfer it will close the 401(k) account, as no funds would be left in the account. This transaction is tax-free, as a trustee-to-trustee transfer.

New Employer's 401(k)

If you begin work for a new employer that offers its own 401(k) plan, you can perform a trustee-to-trustee transfer of the assets from your old 401(k) to the new company's plan. The steps for this are similar to those for an IRA rollover, except that your new company's plan administrator or human resources department will help with the transfer. Generally, you can transfer funds immediately upon beginning work, and you're not subject to any waiting periods that the company requires for plan participation. You also might be eligible for plan loans under the new employer's plans, whereas a transfer to an IRA isn't eligible for loans.

Special Rules If You're at Least 55

If you terminated employment for any reason with a company and you're 55 or older, you can withdraw money from your 401(k) without the usual 10 percent penalty. By requesting a withdrawal of the entire balance, you can close your account. But keep in mind that you'll still pay taxes on the entire withdrawal, at the regular income tax rate.

References

• Internal Revenue Service: Topic Number 558 - Additional Tax on Early Distributions from Retirement Plans Other Than IRAs
• Internal Revenue Service: Rollovers of Retirement Plan and IRA Distribution
• Urgent! Cash under the table jobs in Los Angeles, CA - July 2020 (with Salaries!) | Jooble
• Internal Revenue Service: Retirement Plans FAQs regarding Hardship Distributions

Writer Bio

Craig Woodman began writing professionally in 2007. Woodman's articles have been published in "Professional Distributor" magazine and in various online publications. He has written extensively on automotive issues, business, personal finance and recreational vehicles. Woodman is pursuing a Bachelor of Science in finance through online education.

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