Small Balance Cashouts and Auto-Portability: Managing Former Employees' Accounts

Every plan accumulates them: small accounts belonging to people who left the company years ago. A seasonal worker who stayed six months. A new hire who left before the first anniversary. Each account may hold only a few hundred or a few thousand dollars, but together they create real work for the plan.

The law gives sponsors tools to manage these balances. Used thoughtfully, they can reduce costs and administrative burden while helping former employees keep their savings working for retirement.

Why small balances matter

Small accounts affect the plan in several ways:

• Cost. Many recordkeepers charge per-participant fees. Whether the plan or the employer pays, small accounts can carry a disproportionate share of the cost.
• Paperwork. Former employees still receive required notices, disclosures, and statements.
• Participant counts. Every account balance counts toward the number that determines whether a plan needs an annual independent audit.
• Lost contact. The longer a former employee's account sits, the more likely the plan loses track of them. Missing participants and uncashed checks create their own fiduciary headaches.

How involuntary distributions work

If the plan document includes the provision, a plan can distribute a former employee's vested balance without their consent when it falls under a set threshold. SECURE 2.0 raised that threshold from $5,000 to $7,000 for distributions made after December 31, 2023. The higher limit is optional, so a plan may still be using $5,000 until it adopts the change. A plan can also choose to disregard rollover contributions when measuring the balance, which can bring more accounts under the threshold.

The process generally works like this:

1. The former employee receives a notice explaining their options: roll the money to an IRA or a new employer's plan, take a cash distribution, or, if eligible, leave it in the plan for now.
2. If they respond, the plan follows their instructions.
3. If they do not respond within the notice period, the plan acts on its own terms.

What happens next depends on the balance:

• $1,000 or less: The plan may pay the balance in cash, with mandatory federal tax withholding. A former employee under age 59½ may also owe an additional 10% tax. Some plans choose to roll these small balances to an IRA instead.
• More than $1,000, up to the threshold: The plan must roll the money into an IRA established for the participant unless they choose otherwise.

The automatic rollover IRA

Department of Labor regulations provide a safe harbor for plan fiduciaries who roll a balance into an IRA on a participant's behalf. Among the conditions, the money must be invested in a product designed to preserve principal and provide a reasonable rate of return, fees cannot exceed those charged for comparable IRAs, and the plan's summary plan description must describe the process.

These IRAs keep money in a tax-deferred account, which is better for the participant than an unclaimed check. They are not a perfect home. Conservative investments and account fees can wear down a small balance over time if the owner never takes action, which is one reason auto-portability was developed.

Where auto-portability fits

Auto-portability is designed to reconnect small balances with their owners. The Portability Services Network, which went live in November 2023, is owned by a group of large recordkeepers that includes Alight, Empower, Fidelity, Principal, TIAA, and Vanguard, with Retirement Clearinghouse operating the network.

Here is the basic idea. When a small balance is rolled into an automatic rollover IRA, the network periodically checks whether that person has an active account in a new employer's plan at a participating recordkeeper. If it finds a match, the money can be moved into the new plan automatically, unless the participant opts out. SECURE 2.0 created a statutory prohibited transaction exemption for these transactions, subject to conditions.

According to industry reporting, nearly 21,000 plan sponsors had adopted auto-portability through the network as of September 30, 2025. Availability depends on your recordkeeper, and many recordkeepers that serve smaller plans do not participate. Fees may apply to the transfer, so ask your provider for details.

Steps for plan sponsors

1. Read your plan document. Confirm whether it allows involuntary distributions, which threshold it uses, and whether rollover contributions are excluded.
2. Coordinate with your restatement. Many plans are updating their documents for SECURE 2.0. This is a natural time to decide whether to adopt the $7,000 limit.
3. Process on a schedule. Quarterly or annual processing keeps small balances from piling up.
4. Clean up addresses first. Notices sent to old addresses defeat the purpose and can create missing participant problems.
5. Ask about auto-portability. Find out whether your recordkeeper participates and what it would cost participants.

Help departing employees decide

The cleanest solution is usually a good conversation at the exit. Give departing employees a clear summary of their options and the tax consequences of cashing out. Many people who take a cash distribution do so because no one explained the alternatives.

Want help reviewing how your plan handles former employees' accounts? Brian Williams, CPFA®, of Northshire Consulting LLC | Registered Investment Advisory Firm works with business owners on plan operations and design. Call 203-401-6062, email bwilliams@northshireconsulting.com, or visit northshireconsulting.com to schedule a plan review.

Frequently asked questions

Do we need a former employee's consent to distribute a small balance?

Not if the vested balance is under your plan's threshold and the plan document allows involuntary distributions. The participant must still receive notice and a chance to choose how the money is distributed.

Can we force out former employees with larger balances?

Generally, no. For balances above the threshold, the participant's consent is required until they reach the later of age 62 or the plan's normal retirement age.

Does auto-portability work with every recordkeeper?

No. It works only when the recordkeepers involved participate in the network. Ask your recordkeeper whether it participates and how the process would work for your plan.

This material is for educational purposes only and is not individualized investment, tax, or legal advice. Advisory services are offered through Northshire Consulting LLC | Registered Investment Advisory Firm.