Good question. While it’s unlikely you see a question on the exam about this exact topic, there are several components that exist in this scenario that could be tested.
First thing to be aware of are vesting periods. 401(k)s and pension plans are qualified plans that are governed and regulated by the Employee Retirement Income Security Act (ERISA). One of the requirements ERISA imposes on qualified plans is for the employer to offer a “reasonable” vesting period for employees to earn their benefits. This relates to the matching component; the amount of money an employer matches in qualified plans are not typically considered property of the employee immediately. Most vesting periods look something like this:
- After 1 year of service = 20%
- After 2 years of service = 40%
- After 3 years of service = 60%
- After 4 years of service = 80%
- After 5 years of service = 100%
Most vesting periods take place over a 5 year period, which is what ERISA considers a “reasonable” amount of time. Keep in mind this does not apply to the employee’s contributions. Those are always property of the employee. The employer match is subject to the vesting period. Let’s assume in your example the employee quits the old company after 2 years of service. With 40% vested, that means the employee keeps 40% of the company match, while the other 60% goes back to the company.
The 40% match plus the employee’s contributions will stay in the 401(k) for the time being. Employers detail these scenarios in their plan documents, which must be made available to all employees. In my experience, most employers do something like this:
For balances below $25,000 → Taxable distribution made to ex-employee if not rolled over within 3 months of termination
For balances $25,000 and above → Account sits in place until instruction from the employee
These are the two typical outcomes for a 401(k) plan left behind. The ex-employee will either receive a check (taxable distribution), or the money will stay invested in the plan until further notice from the ex-employee. In most cases, the investments are typically not switched once the employee leaves. If they were invested in a money market fund, it will stay that way. If they were invested in a growth fund, it will stay that way.
Does this answer your question?