Question: I'll be leaving my company
and currently have about $25,000 in stock issued primarily as company match. Can I have
the company stock issued to me to put into a taxable account? How do I determine the cost
basis and when would I pay capital gains? Also, is there a 10% penalty applied since this
would be an unrealized taxable gain until I sell it? I'm 15 years away from retirement.
TB: The stock can be issued directly
to you or in nominee name to be held by a brokerage firm. The latter approach will make it
easier to sell the stock. In either instance, the stock will be a personal, non-retirement
plan asset.
Your employer is responsible for reporting the distribution to the IRS and providing the
tax basis for the stock. This amount will be reported as taxable income. If you leave your
employer prior to age 55, the cost basis will be taxable as ordinary income and the 10%
early distribution penalty tax will apply.
You tax liability on the appreciation will be governed by when you sell shares of the
stock. The difference between the cost basis and the price you receive when you sell the
stock will be taxable as a capital gain. The early distribution penalty won't apply
regardless of your age if you sell the stock outside the plan.
Question: I worked for an employer who offered a 401(k),
for just one month (January of last year), before I switched to another company (that
doesn't offer a 401(k)).
My former employer deferred 16% of my compensation (which was a month's salary) into the
401(k) plan. The company permits employees to contribute a maximum of 15% of annual
salary. Do I have to withdraw the excess 1% as earnings, even though my total 401(k)
contributions for last year were less than $10,000?
TB: The fact that you contributed 16%
of your pay doesn't result in a violation of any of the maximum contribution limits, which
require a corrective refund. The various legal limits are: maximum–employee–pre-tax–contribution
limit ($10,500), maximum-combined-employee/employer-contribution limit (25% of gross pay
with a $30,000 limit), and the limits placed on highly compensated employees.
Most 401(k) plans contain maximum-employee-contribution limits that may be less than the
legally permissible maximum. Your former employer may have included 15% as a maximum limit
in its plan even though this is less than the legal limit.
If the employer deducted 16% from your pay, the limit set in their plan was violated. Your
former employer apparently is attempting to refund the extra 1% to correct their error.
The various sections of the law and regulations dealing with refunds of excess
contributions don't cover this particular situation because this isn't a violation of any
of the legal limits. The employer has violated the terms of its plan, which creates a
different problem.
Your former employer can ignore the goof, which shouldn't be a problem if you were a
non-highly compensated employee. Otherwise, there is a provision of the law permitting the
refund of contributions made in error to the company. Your former employer could use this
provision to have the money returned to the company and then paid from the company to you
as taxable compensation. If they do anything, this would be their best option in my
opinion.
Question: My husband has a 401(k) plan with his employer.
We're moving soon and we need to take a loan against his 401(k). Can you tell me how this
works? Will we be penalized for the withdrawal? What if we pay the loan back within 30
days?
TB: If the plan permits, your husband
may borrow up to 50% of his vested account value, not to exceed $50,000. His vested
account value becomes the security for the loan.
Money must be withdrawn from the investments he holds in the plan to generate the cash for
the loan. The loan will become an asset of his plan account and it won't be taxable if
it's repaid in a timely manner. Most employers require repayment via payroll deductions.
The loan must be repaid within five years, unless it is used to buy a home.
The loan may be repaid earlier without any penalties. For example, if you need to borrow
the money to cover closing expenses until your current home is sold, you will be able to
do so if your husband's plan permits loans, including repaying the entire unpaid balance
within 30 days. Your husband's employer will deduct loan repayments until the loan is
fully repaid.
Question: My employer matches 401(k) contributions, 75% on
the first 6% of the employee's contributions.
The catch is that the match is made in company stock and the match is only made if the
employee is putting at least 6% of contributions into company stock. Other restrictions
include not being able to sell company stock in the 401(k) until the employee reaches age
50 and company-wide bonuses are given only to those investing contributions into company
stock. With the S&P 500 Index fund available in the 401(k) returning 11-12%
historically and 20% recently, and the company stock returning 4.5% historically, is it
best to stay away from company stock and invest solely in the S&P 500? Are all of
these restrictions legal?
TB: Unfortunately a few employers use
this technique to put pressure on their employees to buy company stock. This arrangement
is still legal, although there was an unsuccessful legislative attempt a couple of years
ago to severely limit the ownership of company stock in retirement plans. Using your
historical return numbers, it will take about 10 years before the S&P Index fund,
without the match, will equal the investment in company stock with the match.
The bonuses also must be considered, which I am unable to do since you didn't indicate the
amount of the bonuses. A bonus of 3% or more, for example, will give the company-stock
investment the advantage for an additional period of years. Some "sleepy" stocks
also suddenly become the latest glamour stock, as a result of a takeover or because the
market cycle suddenly changes, so that the stock of companies from the industry your
employer is engaged in are viewed as substantially undervalued. I would also factor this
potentially favorable occurrence into my decision.
Bottom line: Giving up the 75% match and the bonuses would be tough for me.
Question: My wife and I are both retired. I've taken the
required minimum distributions for two years. I don't qualify for the low-income area.
I've been a little naive. I set up separate trusts for my wife and me to avoid probate and
all the things that my children will have to put up with when the second death occurs.
I've just learned that my 401(k) and my wife's IRA are fully taxable at some horrendous
rate upon the second death. I believe I have several alternatives:
1. Withdraw all of these accounts, pay my taxes, use the proceeds, and place them "In
Trust" for our existing trust accounts.
2. Continue to take minimum distributions and let my children worry about their tax
problem!
3. Take sufficient funds each year for our normal expenses, placing our pension, social
security, and dividends into new trust instruments.
How do I set this up so that my children will not have to go through the probate, estate
taxes, etc.?
TB: The amount remaining in your
401(k) and IRAs after both of your deaths will be subject to both income and estate taxes.
The recipient of these funds will be liable for the income tax. The estate-tax liability
will be determined by the size of your estates. You're correct that the combination of the
two types of taxes can take a large chunk of these funds.
The usage of gifts and trusts can help reduce the size of your taxable estate. You can
also avoid probate by naming beneficiaries to receive specific assets. For example, if
your children are named as secondary beneficiaries of your 401(k) and IRAs, these funds
will pass without incurring probate costs. If your children are well established with high
taxable incomes, you may want to consider naming your grandchildren as the beneficiaries
to take advantage of their lower income-tax brackets.
Frankly, it's impossible to give more specific advice without a comprehensive
understanding of your needs, total assets, etc. I strongly recommend seeking help from a
qualified, independent professional.
Question: I contribute a percentage of my salary to my
401(k), let's say 12%. This amounts to a yearly contribution of $10,600. The question is,
since the limit is $10,500, does my contribution just stop at $10,500 and the $100 is just
included into my taxable income?
TB: The payroll program of your
employer or the payroll service should be programmed to stop deducting money from your pay
when you hit the $10,500 limit. If they goof, the excess must be distributed from the plan
with investment income before April 15th of the following year in order to avoid further
tax problems. In any event, only the $10,500 may be deducted when you file your tax return
for the year.
 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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