Question: Our company failed the ADP
test for 1999. Our record keeper at the time didn't notify us earlier in the year that it
looked as if we were going to fail in December. Is it required to notify us if it looks as
if we are going to fail? The record keeper who completed our ADP test had no suggestions
as to how to correct this problem. Is there anything we can do to correct this, or is it
too late? TB: The
responsibility for passing the ADP test is the employer's. The role of your record keeper
is determined by the contract that your employer has with this organization. Some
providers charge separately for each test that is run. Special work is required for the
record keeper to be able to inform you that you may be failing the ADP test. I don't have
enough information to be able to determine whether they should have alerted you to the
potential problem; however, they should be giving you all the alternatives that are
available for correcting the failure.
There are two basic testing alternatives that you are permitted to use. One is to use the
contribution results for the non-highly compensated employees (NHCE) from the current
year. The other is to use the prior year.
When you use the NHCE result from the prior year, you know exactly how much the
highly compensated employees (HCE) may contribute during the current year. For example, if
the 1999 contribution average for the NHCEs is 4%, you know the average contribution
percentage for the HCEs may not exceed 6% for 2000. All you need to do is monitor the
contributions for the HCEs during 2000 to keep them below this level.
Avoiding excess contributions when you use the average contributions for the NHCEs from
the current year is much more difficult. That's because it is the actual results
after the year has ended that count. Discrimination tests conducted during the year can
help to avoid excess HCE contributions, but these require forecasting and the facts can
also change.
There are several alternatives when a failure occurs. These include refunding the excess
to the appropriate HCEs, using all or a portion of fully vested employer contributions
when you do the ADP test, or having the employer make a special contribution for some or
all NHCEs. This contribution is known as a qualified non-elective contribution (QNEC).
The most cost-effective approach with the QNEC is to make this contribution for the
eligible NHCE or NHCEs who had the lowest income during 1999 if your plan document allows
you to do so. For example, a $100 QNEC for an NHCE who terminated during the year after
earning $1,000 will add 10 points to the NHCE contribution base. This will increase the
NHCE result by a full percentage point if there are only 10 NHCEs.
You should look at your plan document to see what alternatives it provides for corrective
action. You have until the end of this plan year to correct the problem for 1999. Again,
you should consider using prior-year results for the NHCEs and limiting HCEs during the
current year to the appropriate level. Your record keeper should be leading your employer
through this process, including proper planning for this year and beyond. If they are
unwilling to do this, or incapable, your company should consider moving to another
provider.
Question: I have after-tax money
invested in my 401(k). If I choose to withdraw some of that money, will I have to pay a
penalty if I'm under 59ý years old?
TB: You're required to withdraw a
portion of the untaxed investment income when you withdraw after-tax contributions. This
portion is taxable and the 10% penalty tax will apply if you are under age 59ý and still
employed by your employer. The 10% penalty tax won't apply if this company no longer
employs you and you left the company after attaining age 55.
Question: I'm considering rolling over
my 401(k) plan to an IRA. I understand that 401(k) plans are protected from lawsuits by
federal law. I also understand that only some states have laws to protect IRA assets. How
can I find out if my state (NY) has such a law?
If my state doesn't have such a law protecting retirement assets, in your opinion, would
an umbrella policy on my homeowners insurance protect me sufficiently? I'm primarily
concerned about an accident that might occur on my property or an automobile accident.
TB: One way of finding out how your
state laws work is to ask an attorney in your state who works with this area of the law.
You may also be able to get an answer from a staff member in your state representative's
office.
An umbrella policy is always a good idea for individuals who have significant assets. Look
at the exclusions that such a policy contains, so you'll know what things aren't covered.
Also, IRAs aren't as well protected from creditors as 401(k)s, so you should consider this
if you have substantial personal debt.
Question: My husband and I both turned
70 in 1999 and we're still working full time. I've been investing in a 401(k) where I work
for the last four years. I have three questions concerning 401(k) plans.
1) Can I still pay into my 401(k) just as I do now for as long as I work, or is there an
age when I must withdraw my money?
2) Can my husband open up his own 401(k) where he works, and would this be an additional
tax benefit to us? We file a joint return.
3) Are we too old to invest in an IRA? We need some sort of investment so we won't have to
pay income tax on our Social Security as we did this year. Of course, if my husband can
open his own 401(k) that would probably take care of the problem.
TB: Congratulations! As long as you
are both working you don't need to worry about outliving your retirement nest eggs.
1) You're permitted to continue contributing to your 401(k) as long as you remain
employed, regardless of your age. The law was changed recently, eliminating mandatory
distributions for all active employees who are over age 70ý, with the exception of
persons who own 5% or more of their business. Mandatory distributions are still required
for 5% owners commencing during the calendar year after attaining age 70ý.
2) Your husband may contribute to a 401(k) only if his employer offers such a plan. It
isn't possible for individual employees to start a 401(k) plan, but if he can round up a
few fellow co-workers interested in this benefit, they can ask their employer to do so.
3) Your husband is eligible to contribute to a tax-deductible IRA if he isn't covered by
any retirement plan as a result of his employment. He may make a maximum $2,000
tax-deductible contribution to an IRA. You may also make contributions to an IRA. The
extent to which your contributions are tax deductible will depend upon your
combined-adjusted gross income.
I suggest you take a look at our sister site, IRAjunction.com,
and read the "Frequently Asked Questions" section for an explanation of IRA
eligibility and contribution rules.
Withdrawals from an IRA must start by age 70ý even though you and your husband are still
working. Tax-deductible IRA contributions may still be desirable even though minimum
distributions must commence shortly.
Question: We're trying to buy a home
and want to use money from my husband's 401(k) plan. His company says we can only withdraw
$1,500 of my husband's $11,000-plus balance. Why can't we take out more money?
TB: Your husband should ask for an
explanation of why only $1,500 may be withdrawn. The plan may have an internal limit that
has been established as a "corporate policy" perhaps as a result of how the plan
investments are structured. Another possibility is that the plan administrator has
reviewed your financial situation and has decided that $1,500 is an appropriate limit
because other assets are available to meet this need. Let me know what answer your husband
gets.
Question: Our pension plan is now a
cash-balance plan but I was grandfathered into the defined-benefit plan that preceded it.
I also have a 401(k) plan with a provision that allows me to deposit the value of the
401(k) plan, as of January 1, 1996, into the pension plan in order to increase the annuity
payments.
Is there a good reason to transfer any of the 401(k) money into the pension plan in order
to increase the annuity payments? The annuity payments appear to be about 10% of the
lump-sum value of the pension plan. If the stock market has an 8% historic average rate of
return, the annuity doesn't look too bad. I would like suggestions as to a reasonable
balance of sources of income for retirement.
TB: You need to also consider that
payments end when you die with the annuity option unless you select an option which will
guarantee payments beyond your lifetime. Such a payment option will reduce the annuity
payments you will receive during your lifetime.
The correct answer depends upon what is most important to you. Transferring your 401(k)
balance to the pension will convert this sum into an income stream that you can't outlive.
For some, this lifetime guarantee is more important than anything else, including leaving
the balance to heirs.
I prefer the flexibility of non-annuity alternatives such as putting the money into mutual
funds and using a monthly withdrawal arrangement. This will give you the flexibility to
increase or decrease withdrawals as may be required. For example, you are likely to need a
larger income 15 years from now due to inflation. Your annuity payments will be fixed so
the buying power will diminish over time. If you transfer this money into an IRA, any
balance remaining will pass to your heirs. You will already have guaranteed income from
both your pension and Social Security, so taking a little risk with this money is
reasonable.
I recommend seriously considering the mutual-fund IRA alternative unless you really don't
want to be bothered by managing this sum during your retirement years.
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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