Question: My wife died recently while employed with a U.S. government agency. Before her death, I was listed on the 401(k) plan as a 50 percent beneficiary and our two grown children were named to evenly split the remainder. Could my wife do this without a spousal written waiver? I've read that the spouse is automatically the 100 percent beneficiary no matter who is on the beneficiary form, unless he or she has given his or her written waiver. Does this also apply to federal agencies? I need to know the exact law. They claim they are not bound by ERISA.

TB: The savings plan that the government has for its employees is exempt from ERISA. It should also be of interest that most of the employment-related laws that Congress has imposed upon all other employers don't apply to themselves.

Years ago, the savings plan for federal employees was subject to the same non-discrimination testing requirements as 401(k) plans. Congress later amended the law exempting the plan because they were unable to gather the necessary data to conduct the tests.

In my opinion, the beneficiary designation your spouse completed is legally binding due to this ERISA exemption.

Question: I am 50 years old. Recently, I was downsized from my company and I took all the money from my 401(k). Can I avoid the 10 percent early withdrawal tax by claiming a hardship?

TB: There isn't any provision in the law for avoiding the 10 percent early withdrawal penalty, even in a situation of extreme hardship such as you have experienced. Unfortunately, you must pay the regular income tax plus the 10 percent penalty tax.

The penalty tax is imposed to discourage employees from using retirement funds for non-retirement purposes. The government provides substantial tax breaks to encourage employees to save for retirement. There is concern that easier access to these funds will cause many employees to deplete their retirement savings.

Question: My employer is starting an employee stock ownership program (ESOP) and has told the workers that the 4 percent of pay they have been matching will now be invested back into the company for their private finance company.

Can a company take your previously contributed 401(k) money and automatically roll it over to this plan? Are there any places or phone numbers to reach out for answers before we get swooned out of what we have already saved?

We are a company of about 100 people and the average employee has been with this company about 15 years. Most people, over the years, have accumulated about $50,000 in their accounts. We're concerned about what we can do. This company is noted for telling you what they want you to know. I'm at a loss for answers and places to turn.

TB: An employer may convert employer contributions that have been invested in a 401(k) plan or another type of defined-contribution retirement plan into company stock via an ESOP, but there is a huge risk in doing so. The trustees who are involved in this decision (probably company officers) are personally liable if this transaction results in investment losses.

I have personally helped several companies, including my former company, establish an ESOP. I have always advised employers to invest only future employer contributions into company stock. Converting prior contributions that are invested (or should be invested) in a diversified portfolio of investments into a single stock is not prudent. I always advise employers not to do this because the fiduciaries are supposed to act solely in the best interest of the participants. Converting prior contributions into company stock wouldn't be considered by a court to be in the best interest of participants. As a result, those involved in this decision could leave themselves exposed to a possible lawsuit from participants if the results aren't good.

You and the other participants can sue those responsible for this decision if a loss occurs. You, of course, have such recourse only if a substantial loss actually occurs.

Question: Our firm just started a 401(k) plan this month (July 2000). An employee wants to know if he can borrow money for a down payment he made on his house in December 1999, and pay the loan back under a longer, 10-year repayment schedule instead of the standard five-year schedule. I want to help him if I can, but I won't jeopardize the plan for him.

TB: You must follow the rules in your plan document, including the loan repayment requirements. The law permits repayment to extend beyond five years if the loan is for the purchase of a primary residence, but your plan document must include such a provision.

You mention that the employee purchased the home in December 1999. Since the home was purchased months ago, I don't see how the employee can claim the purpose of the loan is to cover the down payment. I wouldn't recommend extending the loan beyond five years in this instance due to the timing that is involved.

Question: The small company I'm with has just started a 401(k) plan. I thought this was great until I was told the program is somehow part of an annuity. A previous 401(k) program I participated in only seemed to have mutual funds, with no annuities.

I've read some literature that suggested staying away from any variable annuity within a qualified retirement plan because there are heavy expenses involved. I don't know if I've given enough information for you to respond, but I would appreciate your thoughts.

TB: An annuity, typically, is less desirable than other alternatives for investing 401(k) money. Before you form your opinion, you should get all the facts about the annuity including the following:

a. Is there a front-end fee that is deducted before your money is invested?

b. How much is the annual annuity contract fee? Typically, the insurance company charges a 1 percent to 1.5 percent contract fee, in addition to the fund investment-management fee. This additional fee will substantially reduce your long-term return.

c. Is there a back-end surrender charge? Most variable annuity contracts impose a 5 percent to 7 percent back-end surrender charge which applies to all new money that is deposited. This penalty, typically, disappears after the money has been invested for a certain number of years.

Once you have this information, you should decide whether to participate in the plan. The plan offers some major tax breaks and other benefits that are still worth considering, even if the annuity product has some of the above undesirable features. If there is an employer match of $0.25 or more, this will more than offset the negatives. You may want to encourage your employer to consider other alternatives because the owner and other top-paid employees probably have the most to gain by having the best possible plan.

Question: We currently have two open enrollments per year, January 1 and July 1, when employees can change the amount withheld from their paycheck. Some employees question the legality of this. Is there a law stating that payroll-deduction changes cannot be restricted?

TB: You're required to follow the provisions of your plan document. Restricting employees to changes only twice per year is legally permissible if this is in agreement with your plan document.

I personally recommend permitting employees to change their contribution rates effective as of any payroll period. You have the plan for the benefit of your employees. This added flexibility enables employees to structure their contributions around their needs. For example, an employee may want to increase his or her contributions when he or she receives a raise, or when Social Security payments end.

Most plans give employees the opportunity to change the contribution rate effective as of any pay period. Many also permit employees to make separate contribution selections when bonuses are paid.

You undoubtedly hire employees from other companies that have 401(k) plans, which are much more flexible than yours. These employees realize that your decision to limit them in this manner is arbitrary. As a result, this issue isn't likely to go away. My experience has shown that employees don't abuse this greater flexibility but they do appreciate it. I recommend considering changing your plan.

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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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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