The Experts

Ask the Expert

	By: Ted Benna Creator of the first 401(k) plan
October 17, 2002 This Week, Ted Tackles: I just left my job and want my 401(k) money. But, my employer says I must wait until next year. Is that right? ı Can you explain how the catch-up contribution rules work? ı I'm a highly compensated employee. What is my total contribution limit?

Q: I have about $1,200 in my 401(k) but my job is over. I want to withdraw the money. My employer said I must wait until next spring to take the money. Is that allowed?

TB: Actually, the law says your employer isn't required to pay out this money until you reach retirement age. Yet, most plans permit employees to take their money out shortly after leaving the employer.

Some plans are set up so that distributions occur only once per year, after all the contributions have been made and the accounts are updated. Apparently this is how your employer set up its plan. This is okay if this is how the plan treats all terminated employees.

You should read the section of your 401(k) plan's summary plan description that covers benefit payments. If you don't have the copy that was given to you when you enrolled in the plan, your former employer's benefits department should be able to provide one.

Q: I am 50 years old and I have some questions about catch-up provisions:

If I contributed less than the maximum allowed to my 401(k) in any previous year, how much am I allowed to "catch-up" this year and subsequent years?
What kind of records must I keep to document how much I'm allowed in catch-up contributions, or is my employer responsible for that documentation for 401(k)s?
Are IRAs and 401(k)s both eligible, and are the amounts of "catch-up" interchangeable between them?
Are 457 funds eligible for "catch-up" contributions?

TB: The maximum catch-up contribution for a 401(k) plan this year is $1,000, and the amount will increase by $1,000 each year to $5,000 by 2006. These contributions are possible only if your employer has amended its plan to permit them. All employees over age 50 may make them regardless of how much they contributed during prior years.

By the way, you don't have to worry about documenting the contributions. It is up to the employer to identify the catch-up contributions.

A catch-up contribution is permitted after an employee has hit all other applicable plan limits. Because each year is independent, there isn't any reason to track these amounts beyond the current year.

IRAs and 401(k)s have separate catch-up limits and the two aren't interchangeable. For 2002, the IRA catch-up limit is $500.

In your situation, because you are at least 50 years old in 2002, you may be able to contribute a total of $1,500 in catch-up contributions to your 401(k) (if your employer permits them) and your IRA:

401(k) catch-up = $1,000

IRA catch-up = $500

Total = $1,500

457 plans do allow age-50 catch-up contributions as well as another type of catch-up when you are near retirement. I am not familiar with the rules. I recommend you take a look at the 457 section of this site, including this week's 457 Expert Q&A column, for the applicable rules.

Q: I am a highly compensated employee (HCE). I place 10 percent of my pre-tax income into my 401(k) plan. I would like to contribute more, even after-tax. However, my company's literature says that my pre-tax and after-tax contributions are limited to 10 percent, total -- not 10 percent to one and 10 percent to the other. My company says that the tax-deferred contribution limit for 2002 is $11,000. It also says that my maximum total annual contribution is $40,000 or 100 percent of my compensation.

If, as they say, my pre-tax and after-tax limit is 10 percent total, how could I reach the $40,000 limit unless I contribute both pre- and after-tax dollars?

TB: You are caught in the complex rules that govern these plans. Let me try to sort them out for you.

First, the $40,000 limit you referred to is a combined maximum employee and employer contribution limit. The rule is that total contributions to your plan by you and your employer can't exceed 100 percent of compensation or $40,000, whichever is smaller. Most employees can't contribute this much because they hit other limits. These include the $11,000 maximum pre-tax contribution limit, which is the most an individual may contribute before taxes, plus the $1,000 catch-up contribution, if applicable.

You have a situation that brings another set of limits into play. You are considered a highly compensated employee (HCE).

All 401(k) plans, except those that are designed to satisfy the IRS' safe harbor exemption, are subject to what is known as a discrimination test. This test ensures that the plan is offered fairly to all employees. The government wants to make sure that not just the top executives take advantage of the plan.

The pre- and after-tax contributions that HCEs may contribute are tied to the average percentage of pay that the other employees contribute. This is a method of encouraging top executives to promote the plan and get as many employees to contribute as possible. The more the lower-paid contribute, the more the higher-paid may contribute.

At many companies, the contributions of non-highly compensated employees are so low that HCEs are limited to pre-tax contributions in the range of 4 percent to 6 percent. You are fortunate to be able to contribute 10 percent.

The discrimination test results also apply to after-tax contributions.

You are stuck with these additional limitations. Typically, employers that don't meet the safe harbor requirements must restrict HCE contributions to a level that will make the plan pass these special tests.

Your contributions will be limited to what your employer allows.

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.