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By: Ted Benna Creator of the first 401(k) plan |
April 4, 2002
This Week, Ted Tackles:
I quit my job in 2001, but my employer won't let me roll my 401(k) money into an IRA for five years. Is this legal? ý If Congress said the new 401(k) rules are effective Jan. 1, 2002, why do employers have the choice of when to adopt them? ý Are there any time limits on how long an employer can take to roll over a 401(k) balance from one plan provider to another? ý Can you explain how a 401(k) is split in a divorce?
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Q: I worked for a manufactured-home company for six
years. I resigned in May 2001. Shortly after resigning, I requested that my 401(k) be
rolled into an IRA. The reply was "no," not for at least five years. I need the
$70,000 in my 401(k) to pay for the basics for my family -- medical insurance, utilities,
the mortgage.
I've appealed to all the officers of the company. A vote
was taken among the officers and the answer was "no exceptions will be made."
Thirty-three percent of my 401(k) is in company stock and the remainder is in mutual
funds. The mobile home industry is struggling and it seems dangerous to concentrate my
retirement money in this one investment.
Have you encountered a 401(k) plan that seizes a former
employee's direct and matched contributions for five years after employment has been
terminated?
A: What your former employer is doing is unusual but
is legally permissible. An employer may delay the distribution of benefits, including the
contributions you made, until retirement age (as defined by the plan) if it wishes to do
so.
The provisions dealing with benefit distributions must be
defined in the plan document and these provisions should be explained to participants in
the easier-to-read summary plan description (SPD). You should have received a copy of the
SPD when you enrolled in the plan. If you still have it, read the section that explains
when benefits are paid to terminated employees. Ask your former employer for a copy of the
SPD if you don't have one.
Your former employer is required to operate the plan in
accordance with the provisions of the plan document. Your employer must also do so in a
uniform and nondiscriminatory manner.
Reading the SPD will enable you to determine whether what
your employer is telling you agrees with the benefit-distribution provisions of the plan.
If you doubt you are being treated in a nondiscriminatory manner, a step you can take is
to check with other former employees who have terminated before reaching retirement to see
when they received distributions. If they got the same treatment, I expect you will have
to wait for the five-year period to expire, if this is in agreement with the distribution
provisions of the plan.
You should tell your former employer you plan to ask the
Department of Labor for help if it appears from your research that you aren't being
treated in accordance with the plan rules and how other former employees have been
treated.
Employers that structure their plans with delayed
distributions usually do this to discourage employees from leaving as a way to get their
hands on this money. A reason for having a 401(k) is to help retain good employees. Paying
benefits shortly after employees leave a company can unfortunately create an incentive to
leave, which is why some companies delay distributions.
Given your situation, if your plan permits it you should
consider diversifying your holdings within the plan. You might be able to sell some of the
company stock and use the proceeds to buy other investments offered within the plan. That
said, it's possible you might be restricted from selling your company stock until the
five-year deadline expires.
Q: In the FAQ section on your site, you summarize the
new 401(k) limits taking effect in 2002. But in the second paragraph of the answer, it
says, "Be aware, while these rules become effective in 2002, your ability to take
advantage of some of them depends on when your plan adopts them. Check with your benefits
department for details specific to your plan."
Why does the specific plan have a choice as to when to
adopt them? If Congress has said these are effective on Jan. 1, 2002, why do employers get
such latitude to adopt rules immediately, ignore the rules or pick their own adoption
date?
A: Great question. Congress has passed laws
permitting employers to offer retirement plans like 401(k)s that offer substantial tax
benefits to help employees save for retirement. These provisions in the tax law permit
such opportunities but the plan is voluntary. Employers aren't required to set up a plan
for their employees. As a result, employees working for employers that offer these plans
get a break that other employees don't receive.
The beauty of the 401(k) plan is that the regulations
originally creating it allow employers the flexibility to design a plan that meets the
needs of their employees. Some of the regulations are minimum requirements, others are
maximums. As long as a plan meets these requirements, employers can create rules that work
for their situation. This flexibility also can extend to the speed at which some federal
changes are adopted by employers.
The tax laws were changed last year increasing the
contribution limits and changing other plan rules, but employers are not required to make
all of these changes.
Suppose your plan document contains specific language
regarding maximum contributions. Your employer is required to operate the plan in
accordance with the provisions of the plan as long as these provisions don't violate the
law. That means an employer could cap individual contribution limits at $9,000 a year,
even though in 2002 the federally approved limit is $11,000. As long as the employer
doesn't raise the limit to $15,000 (more than allowed by law), the plan will be operating
legally.
Another example is that the law has been changed to permit
catch-up contributions. Existing plan documents didn't contain a provision for such
contributions. The law now permits them but the plan document must be amended to add this
feature. Employers aren't required to do so and their plans won't be in violation of the
law if they don't do so.
Changes that will violate the law if not implemented, such
as complying with the new, shorter vesting regulations for employer-matching
contributions, must be made whereas other changes are optional. That is the way it
works.
Q: Are there any time limits on how long an employer can
take to roll over a 401(k) balance from one company to another? My employer told me the
process would take three to six months. It also said there are no performance reports
available for my investments for the last six months. I think the company is hiding my
money.
A: I am assuming that your employer is changing from
one provider that handles its 401(k) plan to another.
There aren't any federally mandated time limits for
completing this process but the employer can be liable for adverse results if the
changeover isn't managed well. This is one of the issues that has arisen in the lawsuit
filed by the participants in Enron's 401(k) plan.
The first thing to do when you become uncomfortable with
how your plan is being handled is to stop contributing. This is a painful step,
particularly if your employer offers a matching contribution, but sometimes it is
necessary.
You should also consider telling the person at your company
who oversees the plan that you will contact the Department of Labor (specifically the
Pension and Welfare Benefits Administration) if the matter isn't promptly resolved.
Q: I'm 52 years old and going through a divorce. My wife
wants half of my 401(k). If the divorce-court judge decrees splitting the 401(k) assets
50-50, how will the assets be taxed? I've read there won't be a 10 percent early
withdrawal penalty -- is this true? Will the regular tax liabilities still remain the
same? Who is responsible for any possible tax liability, my ex or me?
In order to pay the possible tax on this early
withdrawal I would have to withdraw even more, thus increasing the tax. That would leave
me with less than half. How do the rules, the plans and the courts remedy this
discrepancy?
A: The court order that splits the 401(k) assets is
called a Qualified Domestic Relations Order, commonly referred to as a QDRO. This is a
rather complex area of the law that gives the non-employee spouse the right to claim a
portion of the employee's retirement benefit as a part of a divorce settlement.
The terms of the QDRO will have to be implemented by your
employer. This commonly is either difficult or impossible to do because the QDRO often
contains demands that your employer can't satisfy -- for example, ordering that the money
be distributed immediately when the plan document doesn't allow for that. As a result, I
recommend that you or your lawyer ask your employer if it has any guidelines for your
plan. If it does, this should help resolve some or all of the issues you have raised.
Given the technicalities of these agreements, make sure your divorce attorney is
experienced in dealing with QDROs.
The specific benefit that your former spouse will receive
must be defined clearly in the QDRO and the employer must be able to comply with this
split. You mention a 50 percent division. That sounds simple, but is it 50 percent as of
the date of the divorce settlement or the date you receive your benefits from the plan?
You likely want it to be 50 percent as of a current date because you know what the assets
in the plan are right now. Suppose it is 50 percent as of the date of the divorce
settlement? You must be sure the account value can be determined as of this date so the
split can be made.
The law governing QDROs permits distributions to the
non-employee spouse at any time after the date the employee spouse attains the earliest
retirement date unless the plan provides for pre-earliest-retirement-age distributions.
Let me explain further. All 401(k) plans specify a "normal retirement age" for
the plan. They may or may not specify an earliest retirement age, such as a provision
allowing early retirement. The regulations pertaining to QDROs specify that
pre-earliest-retirement-age distributions are also permitted. However, your divorced
spouse's ability to get the money depends on whether the plan document also permits
pre-earliest-retirement-age distributions.
The QDRO should include the benefit distribution date, but
this date must agree with the plan provisions. The terms of the QDRO and your plan will
determine when benefits can be paid to your former spouse.
None of these distributions would be subject to a 10
percent early withdrawal penalty, but they would be subject to income tax. Your divorce
settlement should include a provision making your former spouse liable for any taxes
applicable to her distribution.
Another point to consider is the disposition of these funds
if your former spouse dies before the money is distributed. Will this money be paid to
your beneficiary or to one named by your former spouse? If payment is to be made to a
beneficiary selected by your former spouse, you will need to check to see if the plan will
accept a beneficiary designation from the alternate payee.
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Ted Benna, creator of the first 401(k)
retirement savings plan, answers intriguing questions twice a month. With over 40 years of
experience as an employee benefits consultant, Ted is a nationally recognized expert on
benefits issues. He has authored three books, Helping Employees Achieve Retirement
Income Security, Escaping the Coming Retirement Crisis, and Tips for
Successfully Managing Your 401(k), 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. |
 Ted's Table Archives
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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