Question: I want to take advantage of
an early retirement option at age 55, continue to work part time, and move to my weekend
home. My questions are as follows:
May I take distributions from my 401(k) plan to supplement my income based on my tax
bracket at that time? Will there be any penalties? Is there any stipulation to make 401(k)
withdrawals after age 55? Would I be forced to take installments or withdraw certain
amounts on a yearly basis thereafter, as in an IRA? May I take a random yearly amount
based on my current needs and not be penalized?
TB: The key to avoiding the 10% early
withdrawal penalty tax is to leave your employer after you reach age 55. There isn't any
requirement that you must stop working. You can move to your weekend home and work part
time for another employer without fear of this penalty tax.
Legally, you may withdraw whatever amount you want between the ages of 55 and 70ý.
Withdrawals after age 70ý must be sufficient to satisfy the required minimum
distributions.
The major stumbling block will be the distribution provisions of your employer's plan.
Most 401(k) plans permit only lump-sum distributions because installment distributions are
more expensive to administer. You need to check whether your plan requires lump-sum
distributions. If it does, the only way you can take money out each year between age 55
and 59ý, without triggering the 10% penalty tax, will be to roll the money into an IRA
and to take equal annual distributions that meet the annuity rules.
Question: I have an opportunity to work for a company that
offers a matching contribution of $2 for each $1 I put into my 401(k) plan. There is no
vesting period. The problem is the base salary is way below market. First, would you
consider saying yes to this situation yourself? Second, what is the math for determining
how much of a benefit the 401(k) matching is when you consider the federal limits? What
are the 401(k) federal limits?
TB: A 401(k) with a $2 per $1 match
is wonderful but you certainly need to factor the lower pay into your decision. The
maximum amount you may contribute is $10,500. The combined employee/employer maximum is
25% of pay, not to exceed $30,000. The employer match usually is limited to a maximum such
as the first 6% of pay you contribute. Let's assume your plan contains such a limit and
your salary will be $70,000. You will receive $8,400 of matching contributions if you
contribute $4,200 (6% of your $70,000 salary).
The key to your decision is the amount of the salary differential compared to the employer
match. If the salary differential of your current job is significantly more than the
amount of matching contributions offered at the new one, you should keep your job,
everything else being equal.
Question: What's the sequence for deducting a weekly 401(k)
contribution and an insurance premium through Section 125? Is the 401(k) contribution
deducted from the gross wages, then the insurance premium, or vice-versa? Or, is it up to
the payroll department?
TB: Both 401(k) and Section 125
contributions usually are computed starting with gross pay, pre-401(k) and pre-Section
125, contributions. For example, assume your gross pay is $3,000 per pay period, 6% is
deducted for 401(k), and $125 is deducted for Section 125. The 401(k) deduction would be
$180 and $125 would be deducted for Section 125, leaving $2,695 of net income subject to
federal income tax.
The key is how compensation is defined in the 401(k)-plan document. Compensation should be
defined as gross pay, pre-401(k) and pre-Section 125 deductions, and any employer
contributions should be computed using this amount. This is the compensation formula most
plans use.
Question: Can you give me some guidelines on how to choose
a 401(k) company or fund family? There are so many investment companies, brokers, and
third-party administrators in the market. My company has an existing plan but is looking
to switch to a plan with higher performance and lower administrative costs. Of what should
I be aware? How do I really compare the fund performance? Is there anything else I should
consider, such as fees, loads, etc.
TB: The general legal requirement of
ERISA (Employee Retirement Income Security Act) is to make your decision considering
solely what is in the best interest of the participants. The following are the factors I
would consider. There isn't any significance to the order in which these items appear. I
recommend starting the search process by identifying the things that are most important to
you, then evaluating the providers using these factors. My suggested factors are:
A. Are 401(k) plans and services a major part of the provider's business?
B. Does the provider have a large enough 401(k) client base that is likely to be a
long-term survivor in a tough market?
C. If your plan has any unusual provisions, does the provider have experience handling
plans with similar circumstances?
D. What is the provider's target market? What percentage of its client base is similar to
the size of your plan?
E. What support services does the provider give participants? For example: investment
education, investment advice, 24/7-Internet access for information and to conduct
transactions, on-site educational meetings, etc.
F. How robust is the recordkeeping system? Does it operate from a single database in real
time so that anyone accessing the system from any location, and for any reason at the same
time, will see the same information? What are the levels of redundancy?
G. What are all applicable fees, including investment, administrative, transitional, etc.,
and who receives the money? You should insist on knowing how much all the various players
involved will be paid. Remember, no one works for free. Your company or your employees
will pay everyone involved.
H. What's the range of available funds - single or multiple family?
I. What is the quality of the funds? Are they proprietary funds or are they independently
managed funds selected by the provider? If they are independent, what standard does the
provider use to select and/or replace managers?
J. Do you like the team that will be assigned to manage your plan? How long have they been
in the business? How long have they been with this provider?
L. How many clients has the provider lost during the last twelve months and what were the
reasons?
K. Ask for references including some clients that left the provider during the last twelve
months.
Investment performance certainly should be a key factor but you need to look beyond the
mere numbers. You need to consider style consistency, risk taken, etc. I would stay away
from a provider that charges added investment-related fees other than the standard
fund-investment-management fee. This would include front-end, back-end, and wrap fees that
are in addition to the fund-management fee. You should consider using a consultant to help
you if you do not have in-house talent that is experienced in these matters.
Question: I know there are legal requirements that
generally force a beneficiary to take the money out of the 401(k) and a beneficiary isn't
allowed to roll over an inherited 401(k) to his or her own 401(k). Is a beneficiary forced
to take a lump-sum distribution for the whole 401(k)? Does it pay to roll 401(k) money
into an IRA, so a beneficiary can extend the minimum required distributions (depending on
their age), rather than having the beneficiary get hit with lump-sum payment on death?
TB: In most instances, where the
spouse is the beneficiary, the best option is to roll the 401(k) balance directly into an
IRA rather than to take a lump-sum distribution. This will enable the spouse to take
periodic distributions and to preserve the tax-deferred growth on the remaining balance. A
lump-sum distribution usually is the only option available to other beneficiaries.
Question: I'm researching the possibility of starting a
salary-savings program for my company's employees. I read that one advantage of a 401(k)
plan over a SIMPLE IRA is that 401(k) distributions are eligible for averaging provisions.
What exactly are averaging provisions?
TB: The income-averaging provisions
have been eliminated so they aren't an issue. Even if they still existed, they shouldn't
effect the decision you're trying to make.
A SIMPLE IRA does not charge any installation or administrative fees. You also avoid all
the compliance hassles of a standard 401(k) plan. There is a minimum required employer
matching contribution equal to 1% of pay during the first two years with a SIMPLE, but
this amount probably will be less than the fees that have to be paid with a 401(k).
However, the maximum allowed employee contribution is lower than for a 401(k), at $6,000
instead of $10,500.
401(k)s generally don't work well without a matching contribution. I would recommend the
401(k) if the highly compensated want to contribute $10,500 instead of $6,000, and if the
contribution levels of the non-highly compensated employees are likely to be sufficient to
permit this larger contribution. Due to the special non-discrimination tests, the highly
compensated employees frequently are permitted to contribute only 5% or 6% of pay with a
standard 401(k).
A strategy I recommend for many small start-ups is to use the SIMPLE IRA, with a 1%
matching contribution for two years, then to consider a standard 401(k).
 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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