Ted's Table

May 2, 2000

This Week, Ted Tackles: 401(k) plans for people in the U.S. on work visas. ... Is an employer's discretionary contribution counted as income? ... Who pays the taxes when I take an early withdrawal from my 401(k) plan? ... My company sold my unit when I was two months short of vesting. Can I get that money? ... My husband took the money from his 401(k) plan without my required permission. What can I do? ... I took early retirement. How do I roll my money from the 401(k) plan to an IRA?

TB: Participating in the 401(k) is the easiest way to save because the money comes out of your paycheck before you have a chance to spend it. This is the only way most workers are able to save. You should participate in your plan if saving money is a major goal and if the plan will help you achieve this goal.

You're always entitled to get your contributions back, adjusted for investment gains or losses, regardless of how long you contribute to the plan. Most plans don't impose any surrender penalty other than the applicable taxes. Some small employers select investment arrangements that do have a surrender charge, usually equal to about 5% of the total amount accumulated. You should check with the person at your company who oversees your plan to see whether your plan has such a surrender penalty.

Employer contributions are another point to consider. Will your employer contribute to the plan if you contribute, and will you receive all or a portion of the employer contributions if you return to India in three years? You should definitely contribute to the plan if you will receive employer contributions.

The last issue is the most effective way to get your money out of the plan if you return to India. You are legally permitted to leave your money in the plan until retirement age if the amount you have accumulated when you leave exceeds $5,000. You are also permitted to transfer the money into an IRA, and to let it sit there until retirement age regardless of the amount. Either of these options will provide tax-deferred growth until you take the money out.

You may also take the money out of the plan after you leave your employer and pay tax. The amount you withdraw will be taxable and a 10% penalty tax will apply if you leave your employer prior to age 55. If you don't want to leave the money invested in the U.S. until retirement, I recommend taking the money out during the calendar year after you return to India. You probably won't have any other taxable U.S. income during that year. As a result, the tax bite will be substantially less than if you take the money during the last calendar year that you work in the U.S.

Question: Is an employer's discretionary contribution to a 401(k) plan classified as income to the employee? Does it belong on a W-2?

TB: The only contributions included on an employee's W-2 are either pre-tax or after-tax contributions the employee makes. All other contributions made by the employer to a qualified retirement plan aren't reported on an employee's W-2.

Employer contributions go into the plan without employee or employer payroll or income taxes being deducted. Avoiding payroll taxes such as Social Security, Medicare, worker's compensation, and unemployment is a big plus if you receive employer contributions. These taxes are typically equal to approximately 20% for employees who earn less than the Social Security maximum wage base. This is one of the reasons why a plan such as a Simplified Employer Plan (SEP) funded solely by employer contributions is attractive for small employers when the owner's W-2 earnings are below this level.

Question: When I withdraw money from my 401(k) account before retirement, is the penalty and tax paid by the employer or do I pay it when I file my tax return?

TB: The employer is required to withhold 20% of the taxable amount of the distribution for most withdrawals. This 20% satisfies the minimum withholding requirements. This amount is forwarded to the IRS as a credit, similar to taxes that are deducted from your paycheck.

Your actual tax liability is determined when you file your tax return. The 401(k) distribution is added to your other taxable income. Your total tax payable is computed, including the 10% penalty tax. If the total taxes paid during the year are less than the tax due, you will owe the difference.

The typical total tax for early withdrawals from a 401(k) are in the 25% to 41% range. You should consider the total tax bite that you will have to pay before you take a withdrawal. For example, if 41% will be lost in taxes and only 20% is withheld, you should either pay the additional 21% as an estimated tax payment or hold it to pay the tax when you file your return.

Question: My former employer required five years of service in order for the matching contributions to be vested. I was two months short of five years when they sold our division. They told us they didn't have other positions for us and to go apply with the company they sold the contracts to. I was sent paperwork saying I must move my 401(k) in 30 days or it would be disbursed to me minus the 10% penalty and 20% tax. It would also be minus the company match I'm two months short of getting.

Are there any laws that protect against an employer doing this? I heard a rumor that if you had four years and 1,000 hours of service, not including overtime or vacation, that they had to pay out the company-match portion. Is there any hope?

TB: First, if the 401(k) account balance, consisting of your contributions and any profits on those contributions, exceeds $5,000, your employer can't legally force you to withdraw the money prior to retirement age.

Regarding the vesting question, there are two methods of counting years of service. One is the elapsed time method, where years are determined by counting the actual period of employment. With this method, you must have been employed for 60 months to receive credit for five years of service. The number of hours worked is not relevant.

The other method of counting service is tied to the number of hours worked. A year of service credit is given for each year when you work at least 1,000 hours. There is a 12-month measuring period, which must be the first 12 months of your employment, and may either be the same 12-month period thereafter or the plan year selected by the employer for your plan. It is possible with this method to earn five years of service in less than five full-calendar years.

The method for determining service for your plan should be explained in the Summary Plan Description you should have received when you joined the plan. The answer to your specific question will depend upon how a year of service is defined in your plan.

There is another possible alternative. Full vesting is required when a partial termination of the plan occurs, regardless of the plan's standard vesting schedule. This provision is in the law to protect workers in situations such as yours where you lost your job because part of the business was sold. I recommend contacting your former employer to say you are entitled to the employer contributions because a partial termination has occurred. I would also tell them that you will ask the Department of Labor to help if you don't receive the employer contributions. The number for the DOL is: (800) 998-7542.

Question: My husband is permanently disabled as a result of brain surgery three and a half years ago. I requested a loan on his 401(k) and was told the company didn't want to get involved with depositing a monthly check from us to repay the loan. Without my knowledge they sent him a withdrawal application, which he signed to withdraw $42,000. He received a check less 20%, deposited it, and paid our twins' college tuition.

His plan (ERISA) clearly states that any loans or withdrawals must have the spouses' notarized signature. I didn't sign anything. What do I do?

TB: You should inform the person who oversees the 401(k) plan at your husband's company that you didn't sign the withdrawal application, and ask how the money was distributed without your consent. I've seen instances where the participant or a friend has forged the spouse's signature. The other possibility is that someone overlooked the spousal waiver. You deserve an answer. Once you have it, you need to decide what action to take. You should probably consult an attorney once you have the answer.

Question: : Under current law, if I'm 55 years or older and stop working, I can take distributions from my 401(k) at any time in any amount. I know this works if your employer allows it and mine does. The 10% penalty tax wouldn't apply under this circumstance.

If I want to roll the money into an IRA, do I have to roll the full amount and therefore be unable to take distributions of any amount at any time? Can I start taking distributions and then roll money into an IRA—all the money or some of the money? Can I roll some of the money into an IRA and leave some in the 401(k) to then withdraw at any time in any amount?

TB: The 10% penalty tax doesn't apply if you left your employer after attaining age 55. The penalty tax still applies if you are now over age 55 but you left your employer prior to attaining age 55.

First, your options are tied to the plan document of your former employer. Most 401(k) plans require you to take all the money as a single, lump-sum payment. In such an instance, you can take a portion and have the rest transferred directly to an IRA. Assume you have a total of $50,000. You could take $10,000 and have the remaining $40,000 transferred directly to an IRA. You should directly move that $40,000 to the IRA with what is known as a trustee-to-trustee transfer, otherwise 20% of the entire amount will be withheld for taxes.

If your 401(k) plan permits, you may take just some of the money and leave the rest in the 401(k). You can either put the money you withdraw in your pocket or roll all or some of it into an IRA. In either case, 20% of the entire distribution will be deducted for taxes. You can avoid this deduction by directly transferring the portion you want to go into an IRA. The amount you transfer into an IRA may not be withdrawn prior to age 59ý without triggering the 10% penalty tax, unless you take an "annuity" income stream from the IRA.

Assuming you left your employer after age 55 and you are permitted to access the money in the 401(k) as you wish, you should consider leaving all the money in the 401(k) until you reach age 59ý. Otherwise, consider transferring at one shot the amount you want to put in an IRA.

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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