The Experts

Ask the Expert

	By: Ted Benna Creator of the first 401(k) plan
November 7, 2002 This Week, Ted Tackles: What are the tax consequences to my spouse, or to my son if my spouse predeceases me, when inheriting my 401(k) after I die? ı Where can I find the guidelines concerning contributions to my employer's profit-sharing plan? ı Under what circumstances is a 401(k) loan permitted?

Q: I have $180,000 in my 401(k). I will be 59 1/2 in a few weeks. According to my benefits manual I can either withdraw the money or leave it in place. Here's my question: If I die, what are the tax consequences to my spouse or to my son, if my spouse predeceases me, when inheriting that 401(k)?

I feel the government will want its taxes from someone on the many years of tax-deferred growth the account has had.

TB: You are correct that the government will have its day. The beneficiary will owe taxes on withdrawals. While your first consideration should be your and your wife's needs in retirement, it is also smart to consider the taxes your beneficiaries will have to pay. If you die while money is still in the plan and your wife is living, she will be eligible to roll the money into an IRA so distributions (and taxes on them) can be spread over a number of years. By doing so, she will gain the ability to name the beneficiary for this money (through her IRA).

IRAs generally provide greater opportunity to spread distributions. I recommend using a resource that covers this area in some detail. One is the Retirement Bible, written by Lynn O'Shaughnessy.

Your son, on the other hand, doesn't have this rollover privilege. IRS rules do not allow him to roll your 401(k) money into an IRA. That means he will have to take the distribution from the 401(k) as a lump sum and pay all the applicable taxes at the time.

On the other hand, if he inherits the money from an IRA that either you or your wife held, he will have much greater flexibility when it comes to withdrawals. He can't roll the money into his own IRA, but he can stretch out the withdrawals over his lifetime. That would allow him to preserve the account for a long time.

Since you are 59 1/2 and allowed to take 401(k) withdrawals while you are working (known as in-service withdrawals), you might consider rolling the money to an IRA, thereby giving you and your heirs greater flexibility. And you can continue contributing to the 401(k) as long as you are still employed.

Q: I am the sole employee of a limited liability corporation (L.L.C.). My employers use a profit-sharing plan for their retirement. Now that I have been employed with them two years, and am over 21, I am eligible for a contribution. Where can I find an explanation of the guidelines concerning contributions? One owner-employee contributes the maximum (25 percent of 200,000, or $40,000) and the other has opted out of contributing anything for himself. What are they required to contribute for me -- 25 percent of my salary? Please direct me to additional resources that outline the rules.

TB: The primary rules they must follow when making contributions are those specified in the plan document for the profit-sharing plan. The summary plan description, which you are supposed to receive when you enroll in the plan, is the non-legalese version of the plan document. It should contain a brief explanation of how all contributions are allocated. There are a number of possibilities your employer could be using One is that all contributions are split among eligible participants in proportion to gross earnings. In such an instance each eligible employee receives an equal percentage of pay.

There are other permissible formulas that can be used to reduce the amount the employer has to contribute for lower-paid employees. Some of them are pretty complex.

It's possible that the employer contribution can be reduced to only 3 percent of pay using one of these more complex designs. By the way, you are also legally entitled to review the actual plan document. This is the best way to find out exactly how the contribution is determined.

Q: Under what conditions can you take a loan against a 401(k)?

TB: Each employer sets the rules for loans. But, those rules must satisfy IRS requirements.

The IRS allows loans for any reason, but many employers permit loans only for specific reasons, like buying a home or paying for college education. Many employers don't even permit loans.

For the rules that apply to you, check the summary plan description for your plan or ask your plan's service provider.

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.