Question: Recently I went through a
divorce and was allotted a portion of my former husband's 401(k) plan via a qualified
domestic relations order (QDRO). This is from a defined-contribution plan.
Can I roll over my interest in the plan, the funds held in a separate account for me as
ordered by the QDRO, or must I wait for him to retire or terminate employment? TB: In most instances, the earliest you
are allowed to access your portion is when your former spouse leaves the employer. A
distribution to you is also permitted when your former husband reaches the "earliest
possible retirement age." Since this age varies by plan, you should contact the
person at your former husband's company who oversees the plan to find out when a
distribution will be permitted.
The employer is required to provide a written explanation of your options when you are
eligible to receive this benefit. This should include the opportunity to roll over the
money into an IRA.
Question: Is it normal for a 401(k)
plan to have three different companies involved? We have the local representative for the
investment-management company, an administrative company, and a trustee. Each charges a
pretty hefty fee. So far, we haven't seen a marked improvement in our returns to justify
these fees. Any words of advice?
TB: Many plans operate in a
"bundled" environment, in which essentially all trustee and administrative
functions are provided by the same organization. This organization also manages all the
funds involved or uses a combination of its own and funds from other financial companies.
Having a separate administrative company, trustee, and investment-management company will
generally be more expensive, unless the plan uses either index or institutionally priced
funds.
The major issue is the total level of administrative and investment fees rather than the
number of organizations. A plan with $5 million or more of assets can be run with fees
that total around 1% of plan assets. This will include all administrative, recordkeeping,
and trustee services, plus a high level of educational support to participants.
Plans in the $25 million range can be run for around 0.5% of total plan assets using a
combination of index and managed funds.
Question: I'm 56 years old and will
terminate service with my company next year. I have a highly appreciated 401(k) invested
in company stock. I was told that if I take a lump-sum distribution, in certificate form,
I would have to pay ordinary income tax on my cost basis. When I deposit my certificate
with a brokerage, I can then sell stock as needed and pay only capital-gains tax on the
sale of the stock.
Do I pay capital gains on earnings from the day I receive the certificate or on the
difference between my cost basis and the sales price when I sell? I have to make a
decision on a rollover or taking the lump sum.
TB: The capital-gains tax is based
upon the spread between your cost basis and the selling price. Your cost basis is the
price of the stock when it was contributed to your plan account. That is also the price
used for your ordinary income-tax calculations.
The exception to this rule is at death, under current law, when the stock remaining passes
to your heirs without capital-gains tax. The heirs' tax basis becomes the share value at
the time they receive the stock. This can be a huge tax break for them when the current
value of the stock greatly exceeds the value when it was contributed to the plan. For
example, assume you leave $1 million of stock that had a value of $25,000 when it was
contributed to your plan account. The entire gain escapes both income and capital-gains
tax. Your heirs will pay tax only on the gain that occurs after they receive the stock.
Of course, of more immediate concern is providing an adequate income during your
retirement years. Most financial advisers would recommend rolling over the entire amount
that isn't invested in stock and taking a taxable distribution of the stock. They would
also recommend using assets other than the stock to provide your income first and selling
the stock only when you have to do so. However, retaining a substantial amount in one
stock during your retirement years leaves you exposed to a lack of diversification. I
recommend seeking help from an independent professional adviser.
Question: My employer's 401(k)-matching
contributions vest immediately. However, these matching funds don't seem to be deposited
on any regular basis. Are there any timetables as to when the employer must place the
401(k)-matching contributions into the account?
TB: The employer doesn't have to
contribute its contribution until the date its federal tax return is filed. For a company
that has a calendar-fiscal year, the deadline for filing the tax return is March 15 of the
following year. This deadline can be extended until September 15 by requesting a filing
extension. The employer could wait until this deadline and contribute the entire
contribution at that time.
For example, an employer whose fiscal year ended on December 31, 1999 has until September
15, 2000 to make the contribution for 1999 using filing extensions. Anything your employer
does that beats this schedule satisfies the legal requirement. This flexibility is given
because the employer contribution is voluntary — employers don't have to include a
matching contribution.
Question: The company I work for has
been purchased by another company and the 401(k) plan was terminated. I understand the
funds in the plan will be frozen for nine months (no transactions at all can be made). If
my investment choices start to lose money, does this mean I can do nothing but watch the
value of my account decrease?
TB: The answer to your question is
probably, yes, there isn't anything you can do but watch. You and the other participants
should have been informed that your money would be "frozen" during this period,
and you should have also been given an opportunity to shift your money in advance of the
freeze. Failure to inform you in advance, and to give you an opportunity to change your
investments, would generally be considered to be imprudent, giving you and the other
participants grounds for legal action if you do incur a substantial loss during this
period.
Question: What's the difference between
a CODA plan and a 401(k) plan?
TB: A CODA and 401(k) are essentially
the same thing. The term CODA stands for cash or deferred arrangement. Your pre-tax
contribution to a 401(k) plan is possible because the law allows you to receive this
amount as either cash or to put it into the plan. Federal-income taxes are deferred when
the money is contributed to the plan, which is where the word "deferred" is
used. The cash portion is subject to federal-income tax.
Section 401(k) of the Internal Revenue Service code established the legal framework for
this arrangement when it was added in 1978. Subsequently, these plans took their name from
the section, which made it all possible.
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
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