Former Employer Closed Out My 401(k)

My former employer closed out my 401(k) and sent me a check for the balance.  They didn’t tell me they were going to do this but since I had a balance of $175 in the account I wasn’t surprised that they closed it.  They didn’t withold any taxes from the check.  I believe I’ll owe tax on this money unless I roll it over to a traditional IRA.  I don’t have a traditional IRA and I don’t think it is worthwhile to open one just to contribute such a small amount.  I could put the money in my Roth IRA but I’d still owe taxes on it.  I’m wondering if I will owe a penalty for early distribution.  I’m thinking I shouldn’t since I didn’t initiate the withdrawal but I’m not sure.  My thinking is that I can do whatever I want with this money as long as I declare it as income.  They didn’t close the account until this year so it shouldn’t have any effect on my 2008 taxes.  If anyone has any knowledge of whether my thinking is correct or not or has more information on this subject I’d love to hear it.

8 thoughts on “Former Employer Closed Out My 401(k)”

  1. You will have to pay 10% early withdrawal penalty if you don’t deposit the full amount into a qualified retirement account in 60 days.

  2. I’ve put the money in my Roth IRA as a 2009 contribution. I’ll have to declare the $175 as income but I should avoid the early withdrawal penalty. If I’m wrong the taxes and penalties shouldn’t be much on $175. Since this is such a small amount it wasn’t worth setting up a rollover IRA.

  3. You’re going to owe tax if you don’t put it in a tax deferred retirement account within I think 60 days (Roth does not count — its not tax deferred).

    But you may be able to get out of the penalty by using the money to fund your education. The law is pretty flexible on this, rent, utilities, etc. count as educational expenses that will shield 401(k) $ from the penalty (in addition to tuition and fees of course). IIRC, this is called a hardship distribution.

    Here, I would treat the $ as fungible — treat it as if you paid some education expense with the $175, and put some other money into your Roth.

  4. Two seperate issues – tax and penalty. I was bitten by this a few years ago. It doesn’t matter that you did not initiate the transaction.

    If you don’t put the money into an IRA within 60 days of when you recieve the check you will owe a penalty. The 401k people will send you a statement (with a copy to the IRS) at the end of the year. When you fill out your tax forms it will ask you if you rolled the money over within the 60 day deadline or not.

    Tax – if you put the money in a normal IRA you don’t owe tax. You don’t have to create a special IRA for this … you can use the normal IRA you already have (if you already have one).

    Not sure about putting it in a ROTH IRA in a single step.

    I know you can create a normal IRA account just for the rollover, and then convert that IRA into a ROTH.

    It’s only $175 so the amounts are small – but it’s no fun to pay a penalty if you don’t have to.

  5. You’re fine putting the money into a Roth IRA, since it was within the 60 days after the distribution. Like you said, you will pay the tax on the money, but you should avoid the penalty, since a Roth is a qualified plan.

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