Force-Outs: How Do They Work?

By Anthony L. Scialabba IV, Esq., QKA

 

What are “force-outs”?

 

An employer may require former employees to be subject to a force-out (also known as a “cash-out”) provision in a retirement plan’s document. This provision mandates that if the vested account balances of each prior employee does not meet a specified threshold, their respective balance will be removed from the plan. An employer may choose to include or exclude rollovers when determining the vested account balance of a previous employee.

 

What are the force-out thresholds?

 

Each plan’s document may specify a threshold as high as $5,000. If the vested account balance of former employees exceeds $5,000, those former employees may choose to leave their assets in the plan. If $5,000 is selected as the threshold, previous employees who have vested account balances between $1,000 and $5,000 will have their balances rolled over to individual retirement accounts (“IRAs”) established in their names. Prior employees with vested account balances under $1,000 will receive their balances via a check subject to penalties if applicable.

 

Are there any tax consequences?

 

If the distribution is not rolled over to an IRA or another qualified plan, the entire amount will be subject to federal and state income taxes and, in certain situations, excise taxes. The prior employee will be responsible for all taxes payable on amounts not rolled over to an IRA or another qualified plan. The Internal Revenue Service requires 20 percent withheld on an early distribution. This mandatory withholding will not represent the former employee’s actual income tax obligation, which may be more or less, depending on that former employee’s income tax circumstances. 

 

Why is it important to understand a force-out provision?

 

By discussing the ramifications of a force-out provision with an employee when first eligible, an employer can assist that employee to avoid tax consequences when transitioning to the status of a previous employee and potentially becoming subject to that force-out provision. In doing so, the employer demonstrates an extensive commitment to the retirement readiness of that employee.

 

Must a prior employee be supplied with notice?

 

To process the force-out, the plan sponsor must provide a prior employee with notice of at least 30 days to choose to take a distribution of cash or rollover into an IRA or another tax-qualified plan. The notice must describe what will occur if an election is not made. The notice must also specify the deadline to make an election. RetireWell Administrators, Inc. can prepare and deliver notices on your behalf.

 

If you have any questions or comments with regard to force-outs, please call 856-396-0499 or email clientservices@retirewelltpa.com.