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401(k) FAQ

If you are under the age of 59 ½, you cannot withdraw funds from your 401(k) plan to purchase your first home without being subject to a 10 percent additional tax on this early distributions (called a hardship withdrawal). However, depending on the rules for your 401(k) plan, you may be able to borrow money from your 401(k) to purchase your first home. Your plan administrator will have information about your particular plan that explains when you can borrow funds from your 401(k) plan as well as other plan rules.

It is often claimed that one of the reasons that you should not do a 401(k) plan loan is that you will pay income tax twice on the amount. First, the loan repayments are made with after-tax income (that's once) and, second, when you take those payments out as a distribution at retirement you pay income tax on them (that's twice). So yes, you pay twice. But this is the wrong question to be asking.

What you should ask is, "Do I pay more income tax with a 401(k) loan than if I borrowed the dollars using some other type of loan?"

The answer is no, you do not pay any more taxes with a 401(k) loan than you would on any other type of loan.

Think about it. You will be paying off the non-401(k) loan with after-tax income (that's once) and your earnings in your 401(k) (you will have the dollars invested in something since you have not borrowed them) will be taxed at distribution (that's twice). The taxation is exactly the same whether you borrow from your 401(k) or from another source.

The real cost is a possible opportunity loss, i.e., you may be able to earn more investing the dollars than you will from the loan interest over the life of the loan. Plus, there is the danger that if you lose or leave your job, the remaining loan balance is going to become taxable income unless you can pay it off. 

"Yes, when you are an active participant in a retirement plan at work, you may still contribute up to the maximum to a traditional IRA but the contributions may not be fully deductible depending upon the level of your income."

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 adviser regarding your own unique situation and your company's benefits representative for rules specific to your plan.

If you want to retire before age 59½ and begin taking distributions from your 401(k) plan, you will generally be subject to a 10 percent early distribution penalty. The early distribution penalty is the cornerstone of the government's campaign to discourage us from plundering our savings before our golden years.

Of course, with the strong markets, many of us are able to retire before 59½ and we would like to begin getting at our nest egg to do so. Luckily, there are a couple of ways to do this without paying the 10 percent penalty

Leaving Your Job On or After Age 55

If you are retiring from the company that is sponsoring your plan and you are at least 55 at retirement, you can begin to withdraw monthly income from your 401(k) with no penalty. You will owe income tax on the amount. You will need to check with your company’s benefits administrator for details. Your employer is also required to give you a "Summary Plan Description" (SPD) annually and upon request. The SPD should also address early retirement options in your 401(k) plan. If you rollover your 401(k) into an IRA, this option is not available to you.

Substantially Equal Periodic Payments

The substantially equal periodic payment exception is available to anyone with a 401(k) plan, regardless of age, which makes it an attractive escape hatch. It is called a Section 72(t) distribution. In a 72(t) withdrawal, the distributions must be "substantially equal" payments based upon your life expectancy. Once the distributions begin, they must continue for a period of five years or until you reach age 59½, whichever is longest. The full rules and life expectancy tables can be found in IRS Publication 590. This option generally gives you the least retirement pay out available.

These two exceptions are only relevant if you are younger than 59½, since there is no penalty for withdrawals over this age.

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 adviser regarding your own unique situation and your company's benefits representative for rules specific to your plan.

Like loans, hardship withdrawals are allowed by law, but your employer is not required to provide for them in your plan. Again, most companies do, but some don't. The cost of administering such a program can be prohibitive for many small companies. Check with your Human Resources department if you're not sure if your plan allows hardship withdrawal. Like loans, your employer must adhere to some very strict and detailed guidelines.

The IRS code that governs 401(k) plans provides for hardship withdrawals only if: (1) the withdrawal is due to an immediate and heavy financial need; (2) the withdrawal must be necessary to satisfy that need (i.e. you have no other funds or way to meet the need); (3) the withdrawal must not exceed the amount needed by you; (4) you must have first obtained all distribution or nontaxable loans available under the 401(k) plan; and (5) you can't contribute to the 401(k) plan for six months following the withdrawal.

The following four items are considered by the IRS as acceptable reasons for a hardship withdrawal:

1. Un-reimbursed medical expenses for you, your spouse, or dependents.

2. Purchase of an employee's principal residence.

3. Payment of college tuition and related educational costs such as room and board for the next 12 months for you, your spouse, dependents or children who are no longer dependents.

4. Payments necessary to prevent eviction of you from your home, or foreclosure on the mortgage of your principal residence.

5. Beginning on January 1, 2006, you will also be able to make a hardship withdrawal for funeral expenses and repair of a primary residence.

Hardship withdrawals are subject to income tax and, if you are not at least 59½ years of age, the 10 percent withdrawal penalty. You do not have to pay the withdrawal amount back.

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 adviser regarding your own unique situation and your company's benefits representative for rules specific to your plan.

The rules governing 401(k) plans allow plans to provide loans, but do not mandate that an employer make it a plan feature. Even so, loans are a feature of most 401(k) plans. Check with your Human Resources department if you're not sure if your plan allows loans. If offered, your employer must adhere to some very strict and detailed guidelines on making and administering them.

A few of the most common reasons for a loan include, but are not limited to: pay college education expenses for a child, pay un-reimbursed medical expenses, or for a down payment on a home purchase. You must pay the loan back over five years, although this can be extended for a home purchase.

Usually you are allowed to borrow up to 50 percent of your vested account balance to a maximum of $50,000 (set by law). Because of the cost, many plans will also set a minimum amount and restrict the number of loans you can have outstanding at any one time.

If loans are available in your plan, they are pretty easy to get. No credit check is required. Contact your Human Resources department on how to apply. Loan payments will generally be deducted from your payroll checks and, if married, you may need your spouse to consent to the loan.

Funds obtained from a loan are not subject to income tax or the 10 percent early withdrawal penalty. If you should terminate your employment, often any unpaid loan will be distributed to you. This distribution will be subject to income tax and, if you are not at least 59½ years of age, the 10 percent withdrawal penalty. A loan can't be rolled into an IRA.

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 adviser regarding your own unique situation and your company's benefits representative for rules specific to your plan.

A designated Roth account is a feature in new or existing 401(k), 403(b) or governmental 457(b) plans. If a plan includes a designated Roth feature, employees can designate some or all of their elective deferrals as designated Roth contributions (which are included in gross income), rather than traditional, pretax elective contributions.

You may begin making designated Roth contributions to your 401(k), 403(b) or governmental 457(b) plan after you became a participant in a plan that allows contributions to Roth accounts. If your plan doesn’t have a designated Roth feature, the plan sponsor must amend the plan to add this feature before you can make designated Roth contributions.

A qualified distribution is generally a distribution that is made after a five-taxable-year period of participation and is either:

1. made on or after the date you attain age 59½

2. made after your death, or

3. attributable to your being disabled.

If a distribution is made to your alternate payee or beneficiary, then your age, death or disability is used to determine whether the distribution is qualified. The only exception is when the alternate payee or surviving spouse rolls over the distribution to his or her own employer’s designated Roth account, in which case their own age, death or disability is used to determine whether the distribution is qualified.

A qualified distribution from a designated Roth account is not included in your gross income.

The limit on employee elective deferrals (for traditional and safe harbor plans) is:

• $17,500 in 2014 and $18,000 in 2015

• The $18,000 amount may be increased in future years for cost-of-living adjustments

Generally, you aggregate all elective deferrals you made to all plans in which you participate to determine if you have exceeded these limits. If a plan participant’s elective deferrals are more than the annual limit, find out how you can correct this plan mistake.

If permitted by the 401(k) plan, participants who are age 50 or over at the end of the calendar year can also make catch-up contributions. The additional elective deferrals you may contribute is:

• $5,500 to traditional and safe harbor 401(k) plans in 2014 and $6,000 in 2015

• $2,500 to SIMPLE 401(k) plans in 2014 and $3,000 in 2015

• These amounts may be increased in future years for cost-of-living adjustments

You don’t need to be “behind” in your plan contributions in order to be eligible to make these additional elective deferrals.

Required Minimum Distributions (RMDs) generally are minimum amounts that a retirement plan account owner must withdraw annually starting with the year that he or she reaches 70 ½ years of age or, if later, the year in which he or she retires. However, if the retirement plan account is an IRA or the account owner is a 5 percent owner of the business sponsoring the retirement plan, the RMDs must begin once the account holder is age 70 ½, regardless of whether he or she is retired.

Retirement plan participants and IRA owners are responsible for taking the correct amount of RMDs on time every year from their accounts, and they face stiff penalties for failure to take RMDs.

When a retirement plan account owner or IRA owner dies before RMDs have begun, different RMD rules apply to the beneficiary of the account or IRA. Generally, the entire amount of the owner’s benefit must be distributed to the beneficiary who is an individual either (1) within five years of the owner’s death, or (2) over the life of the beneficiary starting no later than one year following the owner’s death. See Publication 590, Individual Retirement Arrangements (IRAs), for complete details on when beneficiaries must start receiving RMDs.

That depends on what you decide to do with your 401(k) money. You have several options:

1. Leave the money: If your vested account balance is $5,000 or more and you're under the plan's normal retirement age, which is commonly age 65, you can leave your money where it is -- and taxes won't be due until you withdraw money from the account. However, if your balance is less than $5,000 and more than $1,000, your employer may decide to automatically roll it into an IRA account on your behalf. If this occurs, there are no tax consequences because the money is moving from one tax-deferred account to another.

2. Roll the money into a new plan or IRA: You can roll over your 401(k) into a rollover IRA account or into your new employer's 401(k) plan. If you do a direct rollover -- have the money transferred directly into the new account -- you won't owe taxes until you withdraw money from the account.

3. Cash out: If you elect to take your money out of the 401(k) and not roll it over into a rollover IRA or another employer-sponsored retirement plan you will owe all applicable taxes. You will also owe a 10 percent early withdrawal penalty unless you leave your company during the year you turn 55 or later.

The penalty is 10 percent of the untaxed money you withdraw, plus applicable federal, state and local taxes on that amount. So if you were to withdraw $5,000 from your 401(k) before age 59 ½, you would owe a penalty of $500 (plus applicable federal, state and local taxes on the entire $5,000).

Providing your plan allows pre-retirement withdrawals, under the following circumstances the IRS says you may withdraw money before age 59 ½ and not have to pay the 10 percent penalty:

1. If you become totally disabled.

2. If you die, and your beneficiary collects the money.

3. If you are in debt for medical expenses that exceed 7.5 percent of your adjusted gross income.

4. If you are required by court order to give the money to your divorced spouse, a child, or a dependent.

5. If you are separated from service (through permanent layoff, termination, quitting or taking early retirement) in the year you turn 55, or later.

6. If you are separated from service and you have set up a payment schedule to withdraw money in substantially equal amounts over the course of your life expectancy. (Once you begin taking this kind of distribution you are required to continue for five years or until you reach age 59 ½, whichever is longer.)

7. If the money is a dividend distribution from an Employee Stock Ownership Plan.

Any money withdrawn for the above reasons would still be subject to applicable federal, state and local income taxes.

 

Under the Employee Retirement Income Security Act of 1974 (ERISA) all 401(k) plan participants are entitled to:

• Examine without charge all plan documents including collective-bargaining agreements, copies of all documents filed by the plan with the U.S. Department of Labor, and detailed annual reports.

• Obtain copies of all plan documents and other information upon written request to the plan administrator. The administrator may make a reasonable charge for these copies.

• Receive a summary of the plan's annual financial report. The administrator is required by law to furnish each participant with a copy of this summary annual report.

• Obtain once a year, without charge, a statement of benefits accrued to the participant.

• Examine without charge at the administrator's office, or obtain upon written request from the administrator, a complete list of the employer and employee organizations sponsoring the plan.

• Upon written request, receive information from the administrator as to whether a particular employer or employee organization is a sponsor of the plan and, if so, receive the sponsor's address.

Additionally, your employer may not fire you or otherwise discriminate against you in any way to prevent you from obtaining a benefit or exercising your rights under ERISA. If your claim for a benefit is denied, you must receive a written explanation of the reason for the denial. You have the right to have the plan administrator review and reconsider your claim.
If you have additional questions about your rights under ERISA, you should contact the Pension and Welfare Benefits Administration division of the U.S. Department of Labor at (202) 219-8776, or on the web at www.dol.gov.

There is no federal agency that guarantees 401(k) plan assets. It is not considered necessary because the value of your balance at retirement is determined by the amount of your contributions and employer matching contributions, and the performance of the investments you choose. (This contrasts with defined-benefit plans, which are guaranteed by the Pension Benefit Guaranty Corporation. Because of the way defined benefit plans operate, it could be possible for accumulated assets to be insufficient to pay the promised benefits when a participant retires.)

It is true that 401(k) participants could lose money if their investments perform badly. That is why it is important to invest wisely. Independent advice providers like mPower exist to give participants tools to make the best possible decisions about their investments.

Also, it is important to note that the Department of Labor's Pension and Welfare Benefits Administration (PWBA) acts as a 401(k) plan watchdog to ensure that employers and trustees follow the rules. There are a number of checks and balances built in to the 401(k) system to safeguard participants' funds. For instance, because your money is held in a custodial account, the account custodian is responsible for protecting your assets on your behalf. Any complaints about the administration of a 401(k) plan that are not adequately answered by the plan administrator can be addressed to the PWBA at (202) 219-8776 or www.dol.gov.

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