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401k Frequently Asked Questions
What is a 401(k) plan? A 401(k) plan is a defined contribution savings plan that allows you to contribute a portion of your salary to a retirement plan account. Because your employer deducts your contributions from your paycheck before taxes, you reduce your current taxable income and pay less in federal income tax right now. Plus, all of your investments grow tax-deferred until you remove money from your account, usually at retirement. Earnings withdrawn before an investor reaches age 59 1/2 may be subject to a 10% IRS penalty.
May I transfer between the different investment options?
What is the maximum I can contribute to my 401(k) plan annually? Generally, you may contribute to your 401(k) plan on a pre-tax basis the lesser of $15,500 (2007) or 100% of compensation, unless you are eligible for Catch-up Contributions of $5,000 more (2007) for a total of $20,500. How can I access money from my 401(k) plan? Loans from your account may be available. And, subject to the guidelines for withdrawal set by the IRS and your employer, 401(k) assets may be withdrawn for any of the following "qualifying events":
1. If allowed by your plan Ordinary income taxes will apply to each withdrawal. Withdrawals received prior to age 59 1/2 may be assessed a 10% federal income tax penalty. When am I required to withdraw my money? You are required to begin receiving benefit payments from your account the later of April 1 of the calendar year following the calendar year in which you:
Failure to begin minimum distributions when required subjects you to IRS penalties equal to 50 percent of the amount that should have been withdrawn but wasn't. What happens if I leave my current employer?
Withdrawals are subject to ordinary income taxes. Withdrawals received prior to age 59 1/2 may be assessed a 10% federal income tax penalty. What happens to my 401(k) plan when I die?Benefits payable upon your death, if any, depend on the allocation of your investment options. Group fixed and variable deferred annuity Who is the plan sponsor? In the case of qualified plans established and maintained by a single employer, the employer is the 401k plan sponsor. What are the duties of the 401k Plan Sponsor?Adopting, executing and amending the necessary plan documents; signing the required IRS reports; Making the contributions to the plan each year. Who is the plan trustee?The 401k plan trustee is the party named in the trust document as authorized to hold the assets of the plan for the exclusive benefit of plan participants. The trustee may function in the capacity of a custodian of the assets or may have exclusive authority and discretion to manage the assets of the plan. What is the 401k trust account?An IRS qualified plan must establish a trust for the sole purpose of holding assets of the plan for the exclusive benefit of plan participants. Depending on the plan provisions, plan assets may be invested in various types of funding vehicles to include, but not necessarily limited to bank accounts, stocks, options, bonds, mutual funds, annuities, life insurance, and direct investments. A 401k plan sponsor may apply to the IRS for an employer identification number (EIN) to be used on the plan investment accounts held by the 401k plan trust. A nine digit number is assigned to identify the 401k plan trust as a separate and official entity not subject to current income tax. In this way, plan assets are distinguished from business assets of the 401k plan sponsor that might be handled by the same investment carrier. PLAN DOCUMENTSWhat are the 401k Plan Documents? All IRS qualified retirement plans under ERISA are required to have a written 401k plan document that establishes the provisions of the plan. The two basic options for 401k plan documents are individually designed and prototypes. Individually designed, or custom 401k plan documents are drafted by attorneys specializing in ERISA. Prototypes are also offered by attorneys, but are more frequently provided by other sponsors. The popularity of prototype plans has increased in the last decade as each round of tax legislation has reduced the advantages available with a custom plan. What is a prototype plan?The IRS designed a program to allow employers to adopt qualified plans without incurring the cost of an individually designed plan. This program is made available by sponsoring organizations such as broker/dealer firms, regulated investment companies, banks or insurance companies, and involves "fill-in-the-blanks-form" plans that are pre-approved by the IRS. The procedures for adopting these plans to assure plan qualification is either automatic or simplified.
How often are 401k plan documents required to be updated? As new tax laws are passed, plans are required to comply with the related changes by a given deadline specified by law. Depending on the nature and the degree of the changes, a plan may either be amended or restated. An amendment makes the changes to or adds specific provisions to the current document; a restatement is an actual rewriting of the entire document. What is the most recent required update?All IRS qualified plans were restated to comply with the Tax Reform Act (TRA) of 1986, Omnibus Budged Reconciliation Act (OBRA) 1986 and 1987, along with subsequent technical corrections. What are the effective dates of the required changes?Required plan amendments must be retroactive to each separately stated effective date of the new laws. Voluntary amendments can be retroactive back only to the first day of the current plan year. Do all 401k plan documents need to be filed and approved by the IRS?The IRS issues favorable determination letters after having reviewed the 401k plan provisions for compliance with the law. Standardized 401k prototype plan documents are completely preapproved through the issuance of "favorable opinion letters" and do not require an individual filing by the adopting employer. The IRS opinion letter is included with the document as part of a plan implementation kit. Non-standardized plans require a short form filing by the adopting employer. The IRS reviews only the adoption agreement and upon approval grants an individual determination letter to that employer. Individually drafted (custom) 401k plans require a long form filing with an IRS review of the entire plan document. What is a determination/opinion letter?A form letter that gives the blessing of the IRS for continued tax qualified status and serves as sort of an insurance policy against potential disqualification. A plan is not required to obtain a determination/opinion letter. PLAN ADMINISTRATIVEWho is the 401k plan administrator?The 401k plan administrator is a person or entity specifically designated in the 401k plan document. If a 401k plan administrator is not so designated, the 401k plan sponsor becomes the 401k plan administrator. What are the duties of the 401k plan administrator?The duties of the 401k plan administrator are described in the 401k plan document. In general, the 401k plan administrator is responsible for all of the reporting and disclosure functions. Federal regulations require that the 401k plan administrator:
The 401k plan administrator may delegate the performance of certain functions to other persons (such as third party administrative firms) and rely on this information, data, or analysis provided that he or she has exercised prudence in their selection and has no reason to doubt their competence or integrity. The 401k plan administrator remains ultimately responsible for the operation and compliance of the plan. What is the first step in Implementing an IRS qualified plan?After the appropriate 401k plan design has been determined, a written 401k plan document must be executed, outlining the provisions of the 401k plan. A 401k plan document must be executed prior to the end of the last day of the plan year in order for the employer to take a tax deduction for that year. The actual contribution deposit does not have to be made until the tax return is filed, including extensions. What is the annual reporting?Generally, a "tax return" for the 401k plan (form 5500 plus any attachments) must be filed as of the end of each plan year, regardless if any contributions were made. A summary of this filing must be given to participants along with statements reflecting their account balances or accrued benefit as of the last day of the plan year. Owner only one person plans may be exempt in certain cases. The Form 5500-series of forms and schedules is printed on special paper with dropout ink so it can be processed by the computerized processing system "EFAST." The Forms 5500 and 5500-EZ (and related schedules) may be obtained by calling 1-800-TAX-FORM (1-800-829-3676). Be sure to order using the IRS form number. When is the 5500 form due?Unless an extension is granted, the 5500 return is due by the last day of the 7th month following the close of the plan year (July 31 for calendar year plans). An extension of up to 2-1/2 months may be granted by the IRS, upon receipt of the application for an extension of time for employee plan returns (Form 5558). An employer may also utilize an extension on the employer's tax return without filing Form 5558. When must contributions be made to be deductible?Tax deductible contributions to a plan may be made at any time during the taxable plan year and even after the end of the year up to the due date (including extensions) for the filing of the employer's tax return for that year. What type of accounting is required?The IRS Form 5500 filings require a reconciliation of assets, in balance sheet and income statement format, as of the annual accounting date, usually the last day of the plan year. This reconciliation must include any accrued contributions or earning. A common misconception is that statements provided by the insurance or investment company satisfy the need for required statements, when in fact they only reflect deposits and don't include accrued contributions. What types of plans require the use of an actuary?Defined benefit plans must be certified by an enrolled actuary as to the methods and assumptions used in calculation of required contributions. Almost all 401K plans are not defined benefit plans, they are defined contribution plans. For Our page on Defined Benefit vs. Defined Contribution click here What federal agencies are involved with the regulation of IRS qualified plans?Department of Labor (DOL) is concerned with protecting rights and benefits of participants and beneficiaries, regulating prohibited transactions of plan assets, monitoring employee disclosure requirements and providing that plan assets are invested prudently. Internal Revenue Service (IRS) is concerned with tax consequences of a plan, regulating amount of tax deductions, level of contributions and benefits, and annual administration compliance issues. It is also responsible for writing regulations and enforcing the Internal Revenue Code. Pension Benefit Guaranty Corporation (PBGC) insures benefits for participants in Defined Benefit plans. Certain Defined Benefit Plans are excluded such as Professional Service Employers which have never had more than 25 participants. How is the employer's contribution allocated to participants?Depending on the terms of the plan, the contribution is allocated based on compensation, years of service, age, or matching basis with employee contributions or some combination of all of these. What are 401k plan forfeitures?Forfeitures are portions of an account balance that a participant loses by terminating employment prior to becoming fully vested. These amounts are reallocated to the remaining participants based on the terms of the plan document. Are 401k plans required to allow participant loans?No. The 401k plan sponsor decides whether to offer loan provisions in the document and has certain latitude in defining these provisions. However, there are maximum limits established by law as well as strict guidelines for repayment. What are PS 58 costs?In plans with life insurance used as a funding vehicle, the value of the pure insurance protection is taxable each year. ELIGIBILITYWhat employees must be included in a plan? As a general rule, any employee that is age 21 and completes one year of service. A year of service for eligibility purposes can mean a calendar year, a plan year, or any consecutive 12 month period in which an employee works 1,000 hours. Can a plan require more than one year of service for eligibility purposes?Plans other than 401(k) plans may set a two-year eligibility requirement, provided that full and immediate vesting be granted upon entry. 401(k) plans cannot require more than one year of service for eligibility. What are the entry dates?The dates specified in 401k plan documents upon which an employee begins participation in the plan, contingent upon satisfaction of eligibility requirements. If one year eligibility is used there must be at least two entry dates no more than six months apart. Who can be excluded from the plan?Union employees covered by a collective bargaining agreement can be excluded, as well as any specific group of employees, provided that the minimum coverage and minimum participation requirements are satisfied. In addition, the conditions for participation may not discriminate in favor of Highly Compensated Employees (HCE). Officers or owners may voluntarily opt out. What are the minimum coverage requirements?A plan must satisfy at least one of the following requirements.
VESTINGWhat is vesting?Vesting represents the nonforfeitable interest of a participant in his or her total account balance (defined contribution plan) or accrued benefit (defined benefit plan). What is a year of service for vesting purposes?A year of service is the 12 month period specified in the plan during which a participant completes at least 1,000 hours of service. What types of plans can have vesting schedules?All IRS qualified pension and profit sharing plans can impose vesting schedules on employer contribution accounts, within specific guidelines. SIMPLE and SEP plans are IRA accounts, thus not permitted to have vesting schedules. What are the minimum vesting standards set by law?If a plan is deemed to be "Top-heavy" the minimum vesting schedules are changes slightly. Top-heavy vesting requires that cliff vesting provides full vesting after 3 years and graded vesting fully vests after 6 years. May any years of service be disregarded for vesting purposes?All of service before an employee reaches age 18 may be disregarded. In addition, a plan may disregard years of service prior to the effective date of the plan, as long as this is applied to ALL participants. Although at first an employer might think this sounds good, and allows greater control, this is usually not a good idea. This provision could well penalize most desirable, long term employees, which are generally the ones intended to benefit from the plan. If an employee incurs a break in service and has not yet become vested, the pre-break service may possibly be disregarded upon rehire. |
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NOTE:
ALL information contained in this site is for illustration purposes only, and by NO means should be considered individual tax or legal advice under any circumstances whatsoever!
Lynn R. Siewert AIMC
© 2008 Advanced Corporate Planning All rights reserved |
