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May 8, 2001
This Week, Ted Tackles: Reader response on tribal 401(k) plans ... I have cancer. Is my 401(k) balance vulnerable if I have to go on state medical disability assistance? ... I want to assign a portion of my 401(k) to a company as collateral to fund a venture with them. The company wants a written guarantee and legal assurance that it will get my 401(k) money if I'm unable to repay the loan. Is this legal?
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Last time, I asked for help from anyone who is familiar
with any special provision to exempt tribal plans from needing to file an IRS Form 5500
(the 401(k) annual report) and we got it from a group of benefits industry attorneys and
other experts at Tagdata.com. Below is an excerpt from the message they sent. I would like
to thank them for their help. —Ted
"Indian tribal governments, subdivisions of Indian
tribal governments, agencies or instrumentalities of Indian tribal governments, or
subdivisions thereof, may offer 401(k) plans to their employees (Code Sec.
401(k)(4)(B)(iii)). The specific authorization for 401(k) plans maintained by Indian
tribal governments is effective for plan years beginning in 1997. They do not have to file
5500 forms.
"Plans sponsored by Indian tribal governments are
considered governmental plans. Governmental plans are exempt from ERISA's participation,
minimum coverage, vesting, and funding standards (ERISA Sec. 4(b)(1))."
Question: I've been diagnosed with cancer. I have no
medical insurance and will have to try and get Medi-Cal assistance.
I have a 401(k) from a previous job, worth about
$46,000. How can I keep from losing it? The brokerage firm holding my account said I
couldn't put the 401(k) in someone else's name unless I paid taxes and penalties. They
don't know how much that will be, do you? If I do put it in another's name, would we have
to pay taxes again if it is put back into my name? What can I do?
TB: I'm not familiar with the requirements to
qualify for Medi-Cal but in many instances retirement plan assets are not considered when
determining eligibility for various forms of private and public assistance. Make sure you
have the right answer for Medi-Cal purposes. You should consider getting help from an
attorney who is familiar with Medi-Cal. If your retirement funds are a factor
impacting Medi-Cal eligibility, it's possible that transferring your 401(k) to someone
else immediately prior to applying may void your eligibility. If any of our readers have
any input that may help this person, I would appreciate it.
If you try to transfer the money, you will have to pay
income tax. You will also have to pay the 10 percent early distribution penalty if you
were under age 55 when you left your former employer. If you were older than age 55, you
may be able to take your money penalty-free under the early retirement rules. You will
still have to pay income taxes on your withdrawal.
To answer the question of how much you would owe, your
401(k) withdrawals would be added on top of any salary or other income you received and
you would be taxed at your normal income tax rate. The 10 percent penalty would be
assessed on the amount you withdrew from the account.
You may give a maximum of $10,000 to anyone without any
additional tax under the gift tax rules. Typically, you make this gift to a child,
grandchild or other relative. After paying the taxes when you withdraw the money, I expect
you will probably have to make gifts to at least three people to exhaust the entire
amount.
These individuals can give the money back to you in the
future without tax; however, you will have to trust them. Unfortunately this type of
planning commonly goes awry because the other party doesn't stick to his or her end of the
deal.
Question: I want to assign a portion of my 401(k)
savings to a company as collateral to fund a venture I wish to pursue with them. The
company wants a written guarantee and legal assurance that it will get my 401(k) money if
I'm unable to repay the loan. Is this legal, and what options do I have?
My 401(k) plan contains pretax and after-tax
contributions and employer-matching contributions.
TB: The Employee Retirement Income Security Act
(ERISA) prohibits you from assigning your 401(k) benefits. You may violate this
restriction and give the company that loans you the money an assignment but it isn't
legally enforceable. Your employer would be legally required to reject the lender's claim
in the event of a default. The only way your 401(k) money could be used to pay the loan is
if you willingly took the money out of the plan. The plan probably permits you to withdraw
the after-tax money at any time. The pretax money may be withdrawn while you are still
employed only after age 59ý or for one of the financial hardships approved by the IRS.
Repaying a defaulted business loan wouldn't qualify.
Bottom line, the potential lender may consider your 401(k)
money when deciding to make this loan to you, but it also has to consider the fact that
this money will be used to repay the loan only if you willingly take it out of the plan
rather than defaulting. That is a business decision the company will have to make. If I
were that company, I would wonder why you aren't taking out at least the after-tax money
to invest in this venture rather than borrowing from a third party.
From a more personal perspective, I question the soundness
of this venture if the company willing to back you is so concerned about financial
security if you fail that they are asking you to violate the law and assign an asset that
cannot be assigned.
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.
 Read Ted Benna's Biography
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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