Question: I work for a small company with a 401(k) plan that has two company employees as trustees. The contributions via salary deductions are sent to a third-party administrator (TPA) who forwards them to an insurance company. The insurance company primarily offers investment choices of mutual funds from various large fund companies. The insurance company takes a 1.25 percent annual fee via net asset value reduction from the mutual funds, which is paid by the employees. My company pays fees to the TPA to complete forms, loans, etc.

Is there a federal regulation requiring a third-party administrator? Do companies use TPAs to limit investment liability in addition to maintaining accounting records? And, is it possible to maintain 401(k) records in-house and invest straight to a large fund company with the overall goal of reducing "management fees"?

TB: There isn't any legal requirement to have a third-party administrator — there are a variety of alternatives available in the marketplace and your employer can select any of them. However, the fiduciary standard an employer is supposed to follow when picking the investment arrangement is to act solely in the best interest of the employee.

It is possible to pick an alternative arrangement, with or without a third-party administrator, which doesn't include any wrap fee. In some cases, a wrap fee such as the one you mention adds value and in other cases, it doesn't.

The major alternatives are:

1. Select a new "bundled" provider that offers all the services that are needed, including serving as trustee;
2. Select a new third-party administrator who uses funds that don't include any additional asset-based fees; or
3. Obtain software to run the plan internally.

I normally recommend staying away from option No. 3 because the laws and regulations governing these plans are so complex that it is difficult to stay out of trouble running one small plan in-house. A less expensive arrangement should benefit all participants, including those who are responsible for running your company.

Question: My employer offered this example regarding maximum contributions to the company 401(k) plan. An employee has a salary of $50,000; employee makes a 401(k) contribution of $7,500 (a 15 percent payroll deduction); employer makes discretionary profit-sharing contribution of $2,800 (5.6 percent of gross wage); employer makes 401(k) match of $1,000. This results in a total annual contribution of $11,300 ($7,500 + $2,800 + $1,000 = $11,300). The example then states that the maximum allowable contribution from all sources is $10,625 ([$50,000 - $7,500] x 25 percent = $10,625). Consequently, $675 would then be deducted from the profit-sharing contribution in order not to exceed $10,625.

Why is the $7,500 being subtracted from the salary of $50,000 before being multiplied by 25 percent? I thought that the maximum employee contribution was the lesser of 25 percent of total compensation or $30,000. In this example, why would the maximum allowable contribution not be $12,500 ($50,000 x 25 percent = $12,500)?

TB: The example your employer gave you was correct until several years ago when the law was changed permitting the 25 percent limit to be computed using gross pay before pretax contributions to Section 401(k) and 125 plans. The 25 percent limit was computed on taxable rather than gross pay prior to this change in the law. Your employer is a few years behind if they are still using the old approach. The correct limit at this time is 25 percent of $50,000.

Question: I received a letter from my employer stating that my 401(k) plan was terminated as of Dec. 31, 2000, which says: "Please note that the decision to terminate the plan does not affect any contributions or earnings thereon made on your behalf to the 401(k)/profit-sharing plan. We intend to file an application with the IRS for a determination that the plan remains tax-qualified upon its termination. While the application is being processed, we will maintain the plan and assets will remain invested as you have designated. Your accrued benefits will be paid to you in accordance with the terms of the plan as soon as practicable after IRS approval is received."

What will happen to me with this decision, and will I be facing any penalties on receiving this money from my 401(k)? Should I roll this money to another retirement plan and if so, will I have to pay taxes on it? What is this really going to mean for me?

TB: First, it will be perhaps a year or longer before the IRS approves the plan termination and the money can be distributed. You will have to wait patiently because there isn't anything anyone can do to speed up the process. Obtaining IRS approval is advisable when a plan is terminated to protect the tax benefits for both the employer and the participants.

One of the tax benefits you will have once the termination has been approved is to transfer the money directly into an IRA. This will enable you to avoid any tax liability until you decide to withdraw the money from the IRA. I recommend beginning to explore where you want to establish the IRA. I recommend starting a separate IRA account, which will be used solely for this purpose. This account is often called a conduit IRA or a rollover IRA. You will only put your 401(k) assets in this account and nothing else. If you put any other money into the account, it will taint the 401(k) money. By opening this type of account and keeping it pure, it will give you the opportunity at any point in the future to transfer the money into another plan at your current or other employer.

Ted Benna, creator of the first 401(k) retirement savings plan, will answer your most intriguing questions every Tuesday. With over 30 years of experience as an employee benefits consultant, Ted is a nationally recognized expert on benefits issues. He has authored two books, Helping Employees Achieve Retirement Income Security and Escaping the Coming Retirement Crisis, and is President of the 401(k) Association. Ted is a frequent speaker at meetings of 401(k) plan sponsors and participants. His articles and comments have appeared in numerous publications, including The New York Times and The Wall Street Journal.

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The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

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