The Experts

Ask the Expert

By: Ted Benna Creator of the first 401(k) plan

November 21, 2002

This Week, Ted Tackles:
Can you recommend organizations that help individuals develop budgets and control compulsive spending? ı When I file my tax return for the year, can I get back some of the taxes my employer withheld when I took a 401(k) distribution? ı Can you clarify the 401(k) distribution rules? ı My employer decides how to invest our profit-sharing plan money, and his investments are fishy. Can I put the money somewhere else instead?

Q: Can you recommend a list of organizations that can assist individuals with developing budgets and controlling compulsive spending?

TB: Here are a few reputable organizations to check out:

Crown Financial Ministries is a nonprofit national Christian ministry that teaches people how to handle their money. The Web address is www.crown.org, and the phone number is (770) 534-1000.

Debtors Anonymous is a national self-help group modeled after Alcoholics Anonymous that can help you keep out of debt. The Web address is www.debtorsanonymous.org and the phone number is (781) 453-2743.

The National Foundation for Consumer Credit is a national network of nonprofit consumer credit counseling services. You can reach the NFCC at www.nfcc.org or (800) 388-2227.

Q: If I withdraw money from my 401(k) before reaching age 59 1/2, I know that 20 percent of the amount will be withheld for taxes. When I file my tax return for the year, can I get back some of these taxes?

TB: The taxes withheld by your employer when you take money out of the plan are, in most cases, only a deposit toward the actual taxes you will owe. The amount of your distribution must be added to your other income for the year. Then, the withdrawal will be taxed at the applicable tax rate plus the 10 percent early withdrawal penalty tax if you are under age 59 1/2 and are still employed.

Whether you will owe additional taxes, or are due a refund, will depend upon the total taxes you have paid during the year compared to the total taxes you owe. For most people, the total taxes they have to pay on an early distribution from a 401(k) are in the 35 percent to 45 percent range. This includes the regular income tax plus the 10 percent penalty tax.

Q: You say that a non-spouse beneficiary has to take the 401(k) as a lump sum and pay all the taxes. But mPower Cafe's article on "Seven Common Errors 401(k) Beneficiaries Make" (published Jan. 9, 2001) states that a 401(k) non-spouse beneficiary can take minimum withdrawals over his or her life expectancy. This is not the same as a lump-sum distribution.

The option to take minimum withdrawals is far more beneficial from a tax perspective. Can you please clarify? Don't both inherited 401(k)s and IRAs allow this option?

TB: The answer is that it depends on what the specific 401(k) plan allows. IRA distributions are dictated by the terms of the IRA custodial agreement. Most of them are pretty generous, and there is more uniformity among IRAs because of the competitive nature of this market.

I based my statements on what I commonly see in my role as a consultant to the 401(k) industry. Most employers don't want to be bothered with periodic distributions from their 401(k)s. So, they permit only lump-sum distributions regardless of the recipient.

The 401(k) plan may provide for distributions over the life expectancy of the beneficiary, but most plans don't include this option. You will have to check with your employer or your benefactor's employer to see what payment options are available to you.

Q: My employer is a securities firm. The owner of the firm funds our profit-sharing plan entirely by himself. He uses the profit-sharing money to fund mutual funds that he opens. The mutual funds have lost half of their value in the last two years. Employees do not have a choice as to where the profit-sharing money is invested. The board of directors for the mutual funds decide, along with the owner of the company.

Is this legal for my employer to do? Can I request that my profit-sharing money be put in a money market account to prevent further loss?

TB: Your employer is legally permitted to control how the profit-sharing money is invested. In fact, a few employers also control how employee 401(k) contributions are invested.

However, your employer is required by law to select investments that are prudent and that are chosen considering only the best interests of the employees. Investing 100 percent of this money into aggressive stock funds where the value drops by 50 percent would generally not be considered prudent.

You can ask the employer to change the plan so employees have future investment control, but your employer doesn't have to agree to do this. You can also sue your employer for improper investing of the funds, but that has a different set of risks.

By the way, a recent survey conducted by the Profit Sharing/401(k) Council of America shows that over 90 percent of employers let employees decide how to invest the profit-sharing contribution.

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.