Question: My employer's 401(k) plan allows "in-service withdrawals" at any age (with no hardship requirement) for elective contributions that were made prior to 1980 and which have been maintained in a separately itemized subaccount. This program was somehow grandfathered from the old profit-sharing deferral plan. No one in the company can explain to me the law change that causes pretax contributions made before 1980 to be treated differently. Do you have any insight into the law change that was effective in 1980?

TB: My best guess is that your employer maintained a tax-qualified profit-sharing plan that was funded solely by employer contributions that included a cash or deferred feature. If this is correct, you would have been permitted to take up to 50 percent of the annual contribution as a taxable, cash payment or to place this amount into the plan where it would not be taxed until withdrawn.

The law permitted the amount contributed into the plan to be withdrawn during active employment without having to demonstrate that there was a financial hardship. Section 401(k) of the Internal Revenue Code became effective on January 1, 1980. This addition to the law made contributions placed into these plans at an employee's election subject to new restrictions, including allowing "in-service withdrawals" prior to age 59ý only for IRS-approved financial hardships. Amounts accumulated prior to this change continue to be subject to the old law.

Question: I'm 70ý years old, and must withdraw a minimum amount from my 401(k). Can I roll the total amount over into an annuity without that amount being taxed?

TB: You may be required to withdraw the required minimum distribution before you transfer money out of the 401(k) plan. The remaining balance can be transferred into an annuity. The entire amount transferred will be taxable unless the annuity qualifies as an IRA rollover. You will also have to take minimum distributions from the IRA after the rollover.

Bottom line, there isn't any way to escape paying taxes. The best alternative for minimizing the tax bite is to use the method for computing the minimum distribution which produces the least amount of taxable income.

Question: Although I'm on a salary, I do receive time and a half after working 40 hours in a week. As my base salary goes up and down as my hours fluctuate, my employer taxes me at a higher or lower bracket every pay period. It's very confusing.

What seems so simple is that my 401(k) contribution amount is the same dollar amount every pay period. Is this correct or should my employer take out more or less depending on how they decide to tax me that pay period since it fluctuates?

TB: Employers may establish a 401(k) that permits contributions from base pay only. All other compensation such as overtime, bonuses, commissions, etc. may be excluded for contribution purposes. However, plans that don't use total compensation are subject to a special nondiscrimination test. As a result, contributions to most plans are based upon total compensation.

It's also possible for a 401(k) plan to permit employees to contribute either a fixed percentage of pay or a fixed dollar amount each pay period, regardless of the compensation definition that is used in the plan. For example, your plan may permit you to make contributions from your total pay but you may have elected to contribute a specific dollar amount each pay period.

Most plans are structured to deduct a specific percentage of pay each pay period because it is administratively easier to deduct a fixed percentage of pay than a fixed dollar amount. Most employees also prefer this approach. Either method is legally permissible. You should check with your employer to see whether you are permitted to contribute a specific percentage of your total pay if this is your preference.

Question: Can I donate funds in an IRA to a charity and set up a charitable remainder trust with these funds in order to avoid paying income tax? Does a 401(k) have to be converted into an IRA in order to donate the funds?

TB: A charitable remainder trust can be used to reduce the tax bite with either a 401(k) or an IRA. You must name the trust as your sole beneficiary or as one of your beneficiaries. It is my understanding that your heirs can receive benefits from the trust. I recommend discussing this approach with an estate-planning professional. Many of the large, nonprofit institutions and charities also have departments that help with this type of planning.

Question: I took a hardship withdrawal from my 401(k) at my main place of employment and can't contribute to my plan for another 12 months.

I'm now eligible to participate in the 401(k) plan at my second, part-time job with a different employer. Is it legal for me to start making contributions to a second 401(k) if I have taken a hardship withdrawal at my first job?

TB: A hardship withdrawal from the plan at your main place of employment will not impact your eligibility to contribute into the plan of your second, part-time job as long as the two employers are not part of a commonly owned group of businesses. The 12-month contribution suspension applies to all defined-contribution plans maintained by the employer that maintains the plan from which the hardship withdrawal occurs. This restriction doesn't apply to unrelated employers.

Question: I am currently on the 401(k) committee at work and have been for the last several years. I've been upset with the company's current recordkeeper and asked the committee to review several new firms to make a possible switch.

The committee selected a new firm and presented it to our company president. The president asked the committee to review a firm his friend works for. The committee looked at the president's recommended firm, but felt the firm does not measure up to the one we first recommended.

The president has stated that he feels very strongly that the committee should choose his friend. Further, he has even gone as far as saying that if his friend went to another firm, then that is where he would recommend our company move the plan!

I want to know if there is anything that I can do, as a plan participant first and as a committee member second, to show him that this is not in the best interest of his employees and that he is not acting in a prudent manner as it pertains to his/company fiduciary liabilities. Are there any articles that I could show him to convince him that this might be an error?

TB: The legal requirements are very specific. The law that sets the fiduciary standard for the management of 401(k) and other retirement plans is the Employee Retirement Income Security Act (ERISA). The selection of an entity to manage the 401(k) is to be made considering solely what is in the best interest of the employees. This is the standard to be used to determine whether those who are involved in selecting a vendor have fulfilled their fiduciary responsibility.

Using the "buddy" system is common among small employers. The risk to the owner is that he is personally responsible for the results. Participants can sue at anytime in the future claiming that the ERISA fiduciary standard has been violated. It shouldn't be difficult for an attorney representing the plan participants to build a strong case when the president has ignored the advice of your committee and has stated that his buddy will handle the plan regardless of anything else. Ignoring the advice of your committee is also likely to result in a lot of employee discontent.

I can recommend a couple of good ERISA attorneys to your president who will confirm the seriousness of this matter. You should also refer him to the Department of Labor's web site. Specifically, go to What You Should Know About Your Pension Rights. Chapter 8 of this booklet confirms what I have stated above.

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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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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