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By: Ted Benna Creator of the first 401(k) plan |
July 3, 2002
This Week, Ted Tackles:
I'm thinking of stopping contributions to my 401(k) and putting that money in a Roth IRA. What do you think? ý How can I set up a one-person 401(k) plan? ý If my employer is bought and its 401(k) plan is merged with the new firm's, can I still hold on to my old investments? ý I got an unsolicited distribution of my 401(k) balance from a former employer when the account value fell below $5,000. Can I return the money?
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Q: I'm thinking about stopping my monthly contribution
into my 401(k) and putting it into a long-term certificate of deposit held in a Roth IRA.
What do you think?
TB: The tax results are the same with a 401(k) and a
Roth IRA if your tax bracket is the same when you withdraw the money as it is when you
invest it. You will get a better tax result using the 401(k) if your tax bracket is higher
now than when you withdraw the money. The Roth IRA will produce a better result if your
tax bracket is higher when you withdraw the money than your current tax rate.
Yet, there are other points to consider. Your employer may
make a contribution to your 401(k) in the form of profit-sharing or matching
contributions. That is a big plus and is not available with a Roth IRA. The automatic
saving that occurs with a 401(k) account through payroll deduction is another big plus.
Depending on your payroll situation at work, you might be able to set up a similar
arrangement with a Roth IRA if you have direct deposit. If not, you will need to do some
research to figure out how to make regular Roth contributions. The point I'm trying to
make is that this semi-forced method of savings is an effective way to achieve your goals.
Most of us have difficulty achieving the same level of savings without this semi-forced
method.
A Roth IRA does give you greater flexibility if you want to
withdraw the money. It can also be a good tool to use for estate planning.
You mention investing the Roth contributions in a long-term
CD. I suspect from this comment that you may have had bad investment results with the
401(k) and this may be a major reason for your desire to change. If this is the case, you
should first review the investment options in your 401(k) to see if there's a similar
investment option such as a bond or stable value fund. These should give you an investment
return that is comparable to a CD. Bottom line: you should consider all aspects before you
make this change.
Question: How can I set up a new one-person 401(k) plan?
TB: You should contact the organizations that are
marketing these plans so you can compare their products. The following are some that we
are aware of -- but this is for informational purposes and shouldn't be considered an
endorsement of their products: Entrust Administration, John Hancock, AIM, BISYS, and
Salomon Smith Barney.
A word of caution -- these plans aren't necessarily the
best alternative for a one-person business. They make sense only for a one-person business
when a contribution level above 25 percent of pay is desired and the income is less than
$160,000. An owner who earns more than $160,000 can have the business contribute the
$40,000 maximum to a profit-sharing plan. Also, the dynamics about what type of plan is
better change dramatically when other eligible employees are involved.
Better alternatives for many one-person businesses are a
Simplified Employer Pension (SEP) or a standard profit-sharing plan. Either can be set up
by working directly with a good mutual fund company.
By the way, elsewhere on this site is an article explaining
one-person 401(k) plans in more detail. We have provided a link in the "Related
Reading" sidebar.
Q: If my employer is bought by another firm and my
existing 401(k) plan is merged with that of the new company, can I choose to have my
existing 401(k) funds stay where they are and not be merged with the new firm's? The new
company's 401(k) fund performance does not have a very good track record so I would rather
leave my current investments where they are and only make new contributions to the new
employer's plan.
TB: What happens to the money you have in the old
plan is usually determined by the old or the new employer rather than by the plan
participants. A common practice is for the buying company to force participants in the old
plan to sell their shares and to move the money into their plan with its investments --
good or bad. You have no choice when this approach is taken -- your money will be moved
into the new investments whether you like them or not. It is unfortunate when this happens
because it is contrary to how plans should be run. It is also contrary to what
participants are told -- that it is their responsibility to decide how to invest their
money.
I recently met with the human resources director and
benefit manager of a company that had acquired a company of equal size. When I asked them
what they planned to do with the acquired 401(k) they told me they planned to move the
money to their plan. I told them this was a bad decision because many of the employees
from the acquired company wouldn't like it, and it also would put the company at risk of a
suit if things don't go well. I told them they should at least retain the funds from the
acquired plan that were the most popular.
I should also note that the acquired company used one of
the best-known fund companies and the buyer used funds that have recently received bad
press coverage for their poor performance. Still, the company didn't appear to be
influenced by my input.
Q: I was surprised when a distribution check was sent to
me recently. My former employer made the distribution because my account value dropped
below $5,000 due to market conditions. I didn't want this money because of the tax I would
owe and other issues. I was told that I can pay the taxed amount from my own pocket and
then roll over the 401(k). However, I feel that the company should have informed me about
the possible distribution in the first place.
What are the distribution requirements for a termination
distribution? Can the check be returned to the company, as I never requested the
distribution and feel I was not properly notified?
TB: The company should have informed you of your
options, including the opportunity to do a direct rollover into an IRA, shortly after you
left the company. When you leave the money in the plan, the company isn't obligated to
inform you of your options again before they do a forced distribution. Many times
participants are informed of their options shortly after leaving the employer but don't do
anything. The money sits in the former employer's plan until an event occurs that allows
the employer to distribute the money. One such event is having your account drop below
$5,000. Federal law allows employers to automatically distribute 401(k) balances if an
individual's account is worth less than $5,000.
The employer is permitted at that point to do a forced
distribution without informing you. You can't return the money.
As you are aware, you can still do a non-taxable rollover
but you must replace the amount that was deducted for taxes with other funds. If you roll
over only the amount you have available, net of the withheld taxes, the amount of the
withheld taxes will be a taxable distribution. If you were younger than 55 when you left
your employer, you'll also owe a 10 percent early withdrawal penalty on the amount.
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Ted Benna, creator of the first 401(k)
retirement savings plan, answers intriguing questions twice a month. With over 40 years of
experience as an employee benefits consultant, Ted is a nationally recognized expert on
benefits issues. He has authored three books, Helping Employees Achieve Retirement
Income Security, Escaping the Coming Retirement Crisis, and Tips for
Successfully Managing Your 401(k), 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. |
 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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