Question: I've heard there are financial incentives for
employers to offer 401(k) plans, in the form of tax breaks. How can I find out exactly
what these breaks are?
TB: It costs a company to have a
401(k) plan even if there aren't any employer contributions. The employer must pay the
fees associated with starting the plan. The employer must also pay the administrative
fees, at least during the first few years, because the plan assets are not sufficient to
make withdrawing these fees from the plan financially viable. The company is able to
deduct these fees as a business expense but that covers only a relatively small portion of
the actual costs.
Additionally, there are indirect costs. A staff member must spend a lot of time overseeing
the 401(k), even if your employer hires a good third-party administrator. The employer
also assumes certain liability to offer a plan that is in the best interests of its
employees. For example, some participants have sued their employer because they didn't
like the way the plan was managed.
If there is an employer contribution, this also increases the cost. The employer's
contribution to the plan is a tax-deductible business expense but again this covers only
part of the cost. For example, if the employer contribution is $10,000 and the applicable
corporate tax rate is 15%, the tax break is equal to $1,500, leaving a net after-tax-cost
of $8,500.
Bottom line: It costs money for an employer to offer a 401(k), even if there isn't
any employer contribution. Employers offer plans to help their employees save for
retirement and because they may have difficulty hiring and retaining good employees
without one.
Question: I plan on retiring at age 51. I once heard that a
person may withdraw a small portion of their 401(k) after retirement based on their life
expectancy. Would you refresh my memory on this formula?
TB: The ordinary life-annuity factor
at age 51 for one life is 32.20. You must divide your account balance by this factor to
get the annual distribution. For example, if your 401(k) balance is $100,000, the annual
distribution would be $3,105.59.
You may use the two-life factor if you have a spouse. This will result in a smaller annual
distribution, though.
You will be able to take annual annuity distributions from your plan only if your
employer's plan permits this type of withdrawal. Most 401(k) plans require you to take
your money in a lump sum. If this is the only option with your plan, you will need to roll
your money directly into an IRA and then structure your annuity distribution from the IRA.
Question: What's the enforcement mechanism of the
"mandatory withdrawal" provisions of an IRA, either to the IRA owner after age
70ý, or to the beneficiary of an IRA? Since the distribution formula that the owner
selected is not reported to the IRS, how does the IRS know how much "should"
have been withdrawn?
Second question: Am I required to select a formula for determining minimum withdrawals and
not change it? Again what is the enforcement mechanism for "not changing" - it
would seem that this becomes a contract between the IRA owner and the trustee (e.g.,
broker, bank, etc.). Suppose I simply transfer the IRA to a new trustee - does the
previous trustee convey the selection to the new trustee?
TB: Most of our tax laws are
dependent upon voluntary compliance, with a little fear of the big, bad IRS thrown in to
get our attention.
Regarding the specific points you raised, I'm not aware of any monitoring system. Of
course, taxes will ultimately be collected on your IRA holdings, it is simply a matter of
when. Given this fact, it doesn't make sense to spend a lot of money monitoring
distributions from these accounts.
Regarding your second question, I'm not an expert in IRAs. You will need to call a firm
that regularly deals with IRA accounts to find out how they handle this.
Question: Should I be more aware of the distribution rules
if, at age 51, I already have over a million dollars in my 401(k) and expect to work for
another 11 years? Might I accumulate "too much" and trigger a penalty?
TB: The law has been changed by
repealing the penalty tax for having too much accumulated, so you don't need to worry
about that issue; however, it still may be advisable for you to funnel more of your future
savings outside the plan.
Accumulating money in tax-deferred vehicles, substantially in excess of what you are
likely to need for your retirement, has a down side. The amount left when you die will be
subject to Federal income and estate taxes. The combination of these taxes can take 70% to
80% of what is left. I would strongly recommend discussing your alternatives with a
qualified, independent professional who is familiar with both qualified retirement plans
and estate planning.
Question: How does the IRS handle partial rollovers? My
wife quit her job and we "cashed in" her 401(k). Let's say it was for $40,000.
After paying the 20% in taxes, we got $32,000. We used $22,000 for a down payment on a new
house and rolled over the remaining $10,000 into an IRA.
TB: The $10,000 is not taxable
provided the rollover was handled properly. You should report the total distribution on
line 16(a) of your Form 1040 tax return and report the taxable portion on line 16(b).
The taxable portion will be subject to the 10% early distribution penalty if your wife is
under age 59ý. The tax payable is reported on line 48 of Form 1040. You may also have to
include a Form 5329.
Question: I retired in 1996 and kept my 401(k) with my
former employer. People have been suggesting I roll the funds into an IRA. My
understanding is the withdrawal rules are different and the 401(k) doesn't peg the
take-out amount to age expectancy. I am satisfied with the investment choices of the
401(k). I'll be 59ý in July. What are your recommendations?
TB: Leaving the money in the plan is
a reasonable alternative if you are comfortable with the investment arrangements. However,
things can change rather quickly. Your former employer could be acquired and all the money
in the current plan could be moved to the buyer's plan. Your former employer could also
decide to totally change investment options at any time. In both of these situations,
there usually is a transition period during which no changes (e.g., withdrawals,
investment transfers, etc.) may occur. I would leave my money in the plan, only if I had a
high level of comfort that such changes were not likely in the foreseeable future.
 Read Ted Benna's Biography
Ted's Table Archives
Ted Benna, creator of the first 401(k) retirement savings
plan, answers 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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