The Experts

Ask the Expert

By: Ted Benna Creator of the first 401(k) plan

July 18, 2002

This Week, Ted Tackles:
My wife's employer says she has to arrange her own retirement account. Is this considered a 401(k)? ı I'm being terminated from my job. Can I make a contribution to my 401(k) from my severance pay? ı I plan to be in the United States for 10 years and then leave for good. Is it worth it to participate in my employer's 401(k) plan? ı I'm 20, and my employer says I need to be 21 to participate in the company 401(k) plan. Why? I want to start saving early.

Q: My wife is starting a new job and the employer offers matching funds up to 5 percent of salary a year to the retirement plan. But the employer does not have a plan provider. My wife has to establish her own account for the money to be sent to. Is this considered a 401(k)? Can you tell me how to locate providers so that an account can be established? If this is not a 401(k), what is it?

TB: What your wife's employer is doing doesn't appear to be proper, if her employer is indeed offering a 401(k) plan. The investment accounts for a 401(k) must be established by the employer using either a trust account, with trustees, or a group annuity contract. In either instance, the account must be a plan account rather than an individual account. From everything I know, the employer isn't doing what is needed to properly operate a 401(k). If this is correct, your wife and the other participants could have tax problems later.

It's possible your wife's employer is offering a SIMPLE IRA, a different type of employer-sponsored retirement plan that involves individual accounts.

SIMPLE plans are designed for companies with fewer than 100 employees. All contributions go into an IRA that is in the participant's name. Each IRA can be set up by the participant wherever he or she wants; however, most employers pick a single financial organization to simplify administration. Banks and brokerage firms are some of the financial companies offering SIMPLE plans.

However, under IRS rules, a SIMPLE plan must match 100 percent of the deferral up to 3 percent of salary, not 5 percent of salary as you mention in your question.

Another possibility is that your wife's employer is offering a 403(b) plan. Some 403(b) plans require participants to choose their own providers. However, these types of 403(b)s generally don't include an employer match.

I would love to see whatever paperwork your wife has for this plan. Please send it to: Clifton Linton, mPower, 1355 Sansome Street, San Francisco, CA 94111. He will forward it to me.

Q: I am being terminated from my job, and will receive a lump sum severance payment (paid through an outside payroll service). Can I make a contribution to my 401(k) from this severance payment to decrease the taxes taken from it?

TB: It is my understanding that you can't make contributions from this money because you will no longer be an employee when you receive the severance payment. However, you should check with your employer to see whether it will permit you to have 401(k) contributions deducted.

Q: I plan to be in the United States for a maximum of 10 more years. After that I plan to leave for good. Is it worth it for me to put money in 401(k) even though I know I will not retire in the U.S. and I will take all my money out by the time I am 35?

What are the penalties for early withdrawal? Are they still less then the benefits the 401(k) has to offer?

TB: I strongly recommend contributing to the 401(k), particularly if there is an employer-matching contribution, because you will be throwing this money away if you don't do so.

The plan should still benefit you even if there isn't an employer match. The amount you contribute comes off the top of your income so the tax benefit gained is at the top rate you pay.

You will have to pay tax when the money is withdrawn, including the 10 percent early distribution penalty if you are under age 55 when you leave the employer and if you take the money in a lump sum. But, you will gain a tax advantage if you wait to withdraw the money during a year when you have no other taxable U.S. income. For example, if you leave your job and the United States during 2012, I recommend withdrawing the money in 2013 or later. This will probably be your only taxable U.S. income, so the regular tax will be computed starting at the lowest rate, plus the 10 percent penalty tax.

Additionally, regardless of the tax consequences, the 401(k) will help you accumulate money that you are likely to spend otherwise.

Q: I have worked for the same company for three years. They said I had to work one year full time before I became eligible for the 401(k). Now they are telling me I have to be 21 years old before I can be eligible to participate. I am 20 now. Is this true? Doesn't that defeat the idea of starting to save early?

TB: Employers are permitted to exclude employees from participating in the 401(k) until they are 21 years old. Most employers that hire a lot of employees who are under age 21 exclude them because most of these employees aren't interested in saving for retirement.

Further, many under-21 employees who do contribute to a 401(k) plan leave the employer after contributing for only a few months. This pattern leaves the employer stuck with the administrative cost -- which is somewhat substantial -- of creating an account to hold only a small amount of savings. This is another reason why employers tend to exclude employees until age 21.

You are correct that this is contrary to the "start saving early" message, but 21 is still considered early for most of us. I congratulate you for having the interest to start early. One way to do that is to contribute to an IRA this year. There are no age restrictions on IRA contributions; you are allowed to contribute up to $3,000 in 2002.

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.

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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.