Question: A recent article on this site stated, "You can't roll over your 401(k) funds into an IRA while you are still working for the same employer just because you don't like the investment choices in your plan."

What if you take retirement at age 59ý but remain as a part-time worker for the same employer. Under these circumstances, would you be able to transfer part or all of your 40l(k) balance into an IRA, but still remain active in the plan?

TB: TB: Withdrawals from a 401(k) plan after age 59ý are legally permitted while you are still employed by the employer that maintains the plan. These distributions may be rolled over into an IRA. So, you may withdraw your money after 59ý and roll it over into your IRA, even if you are still a full-time employee, if your plan permits such withdrawals. Employers aren't required to include this provision in their plans and many don't.

An alternative, if your plan doesn't permit such withdrawals, is to terminate and to come back as a part-time employee. You should, of course, discuss your plans with your employer in advance to make sure they will agree to a transition to part-time employment.

Question: Do employee contributions to a Section 125 plan affect the annual additions limitation (IRC 415[c])? In other words, is a 125 contribution considered an annual addition?

TB: The law was changed a couple of years ago to permit the annual additions limit (IRC 415[c]) to be computed using gross pay before Section 125 and Section 401(k) contributions. The plan document must be amended to adopt this compensation definition for IRC Section 415 purposes.

For those who are not familiar with Internal Revenue Code Sections, 415 is the section that limits the combined employee/employer contributions to the lesser of 25 percent of pay or $30,000. Section 125 permits employees to use pretax contributions to pay medical insurance premiums and other permissible expenses.

Question: When you run the ADP/ACP nondiscrimination tests, what income is used to determine whether an employee is considered highly compensated? For a plan year starting in 2000, is it $85,000 earned this year, or is it $80,000 earned in 1999?

TB: For a plan year starting in 2000, you need to go back to the prior plan year to determine which employees are highly compensated. The compensation limit for plan years prior to 2000 was $80,000. As a result, you should use $80,000 to determine which employees are highly compensated when you do the test for the plan year beginning in 2000. Employees who earned more than $80,000 during the last plan year must be included in the highly compensated employee (HCE) group when you do the ADP/ACP discrimination testing for the plan year beginning in 2000.

The increased $85,000 amount will be used to determine which employees fall into the HCE category when you do the ADP/ACP test for the plan year beginning during 2001. In this instance, those who earn more than $85,000 during the plan year beginning during 2000 will be HCEs for the tests applicable to the plan year beginning during 2001.

The rules are different for 5 percent owners and applicable family members. Any employee who owns at least 5 percent of the business during either the plan year that is being tested or the prior plan year must be included in the HCE group.

Question: What happens if you go past the $10,500 contribution limit for nonhighly paid employees?

TB: When the $10,500 limit is exceeded, the excess amount should be returned with applicable investment income prior to April 15th of the following year. If the excess amount is not returned prior to this date, it must be retained in the plan and it can be distributed only when the employee is eligible for a benefit distribution. It will be taxable when it is distributed, which means it will be taxed twice: when it goes into the plan and when it comes out. As a result, there is a strong incentive to get the excess out of the plan prior to April 15th.

The above results are the same regardless of whether the employee is a highly or nonhighly compensated employee (NHCE). However, it is my understanding that the ADP nondiscrimination test is to be run including the excess if the contribution was made by an HCE, but the excess contribution should be excluded if it was made by an NHCE.

Question: We operate a manufacturing company and offer a 401(k) plan to our workers. Folks in the manufacturing industry typically have low participation rates. What are the potential legal downfalls, if any, of implementing automatic enrollment for our 401(k) participants?

TB: The two major legal concerns I have encountered involve employees who drop out after only one or two deductions have been made, and how to invest the money contributed by employees who don't provide any investment instructions.

The accounts of employees who drop out must be maintained until the employee either leaves the company or qualifies for a hardship withdrawal. The administrative costs are high relative to the size of the account. Mike Iwry, of the Treasury Department, recently asked me, what can be done to further encourage employers to use automatic enrollment? I told him permitting refunds when employees drop out early will be useful. We discussed several ways of accomplishing this. I don't know whether Treasury will eventually permit such refunds, but there was interest.

Employers have been forced to include an investment default, which applies to employees who don't provide investment instructions. Many put the money into the most conservative option in order to reduce the potential of a loss. However, the most conservative option will probably result in a significantly lower long-term investment return than other options.

Employers running 401(k) plans need to remember that they're supposed to operate the plan in the best interests of their employees. There is concern that placing the money into the most conservative investment may not be in the best interest of the employee. The Department of Labor has indicated that more aggressive investments are okay, but this position hasn't been widely publicized.

A nonlegal concern is that many employees will contribute only the minimum automatic amount, which usually is 3 percent of pay. Contributions at this level for an employee's entire career are not likely to produce an adequate level of retirement income.

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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