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What will happen to the money I have in my 401(k) retirement plan when I leave my current employer?

Many workers participate in 401(k) and similar retirement plans that are sponsored by their employers. If the worker leaves the company, the money can either be rolled over into a 401(k) offered by the new employer (assuming the new company offers such a plan) or rolled over into an individual retirement account. Either way, the worker can avoid paying taxes and penalties on the money as long as it is rolled over directly from the old plan either to a new employer-sponsored plan or to an individual retirement account.

If I change jobs, can I leave my money invested in my current employer’s 401(k) plan until I retire?

If you have a 401(k) with your current employer but eventually change jobs, you may be able to leave your 401(k) with your old employer until you retire. Your ability to do so will be based on the size of your vested account balance. According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "If you have more than $5,000 in the plan and you’re under age 65 (or in some cases 62), you have the legal right to leave it where it is. But if your vested balance is less than $5,000, your employer has the right to pay it to you whether you want it or not. You get to choose how to take that distribution, however. It can be made directly to you, to another employer’s 401(k) plan or to a rollover IRA. "Do not have the money paid directly to you. Ask your employer to have it transferred directly to another employer’s 401(k) plan or to a rollover IRA. If you’ve made after-tax 401(k) contributions, those contributions can’t be rolled over into an IRA. Ask your employer to return directly to you any after-tax contributions you made to the plan. You won’t owe any tax on this money because you’ve already paid it. But you can and should roll the interest earned by your after-tax contributions into an IRA along with your pre-tax contributions and earnings, and your employer’s matching contributions and their earnings."

If I change jobs, but I decide to leave my 401(k) account at my former company, can I keep putting money into it?

If you change jobs but decide to leave your 401(k) with your previous employer, you won’t be allowed to make any further contributions to the plan. According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "You can only make pre-tax 401(k) contributions from the salary paid by the plan sponsor. Technically, you participate in the plan by authorizing your employer to take a specific amount out of your compensation and put it into your 401(k) account. In fact, 401(k) plans used to be called salary reduction plans for that very reason."

Can I roll a 401(k) account from my previous job into the plan I have now?

If you recently started working for a new employer that offers its own 401(k), you might be able to roll the old account you had with your previous employer into the new one. According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "Some plans allow you to do this and some plans don’t. Assuming your current 401(k) plan does accept rollovers from other plans, the money must be transferred into the plan directly from your previous employer’s 401(k) plan or from a rollover Individual Retirement Account. Remember, if this money has passed through any type of account other than a 401(k) plan or a rollover IRA (containing only qualified plan distributions), it’s tainted as far as the Internal Revenue Service is concerned. That means it can’t be put back into a 401(k) plan."

What happens to my 401(k) account if I’m fired?

If you are fired, the money you have in your company’s 401(k) will be treated just as if you had resigned. If your vested balance exceeds $5,000, you would have the option of leaving the money in the plan even though you may have left the company under less-than-ideal circumstances.

What happens to my 401(k) if my employer is acquired by another company?

If you have a 401(k) and your employer is acquired by another company, one of several things could happen. 1. If the buyer has other business units that are covered by a single 401(k) plan, your company could be required to join the same plan. After the sale is made final, your new 401(k) contributions may have to go into the new company’s plan, and account balances in the old plan probably will be transferred to the new one. 2. If the buyer prefers to have each of its business units maintain their own benefit program, your old 401(k) plan might be retained with little or no change. 3. The new owner could decide to terminate your 401(k) plan, especially if its other business units don’t offer a plan of their own. If that’s the case, you could preserve the tax-deferred status of your account by having the current 401(k) plan administrator transfer your money directly into a rollover Individual Retirement Account (IRA).

What happens to my 401(k) if my employer goes out of business?

If you have a 401(k) account and your employer goes out of business, don’t worry. The assets in your account will be safe. As explained in "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "As plan fiduciaries, employers are legally required to put 401(k) money into a separate trust account or into a contract with an insurance company within a reasonable amount of time after it has been deducted from their employees’ salaries. A trust is a separate legal entity from the company and will continue to exist even if the company goes out of business. The plan trustees are responsible for managing the money in the plan until all benefits have been paid to the participants. The money in the trust is invested in the different investment choices that are offered by the plan as the participants direct; but no matter how many different investments the plan offers, the money is still in a trust. Your employer’s creditors have no legal claim to these funds."

How are the maximum contribution limits changing for 401(k) and 403(b) plans?

The maximum contribution limit for 401(k) and 403(b) plans will increase gradually from the current limit of $10,500. The limit for 2002 is $11,000, and it increases $1,000 per year until the limit reaches $15,000 in 2006.

How do I contribute to a 401(k) plan?

If you are covered by a 401(k) retirement plan, you won’t write a check out every year in order to fund the account. Instead, part of your contribution will be taken right out of each of your regular paychecks and deposited in the 401(k). Money taken out of your check to fund the account is deducted on a pre-tax basis. The company won’t report the money as income on your W-2, which will lower the taxes you must pay. In addition, money in the 401(k) will grow tax-free until you begin making withdrawals, usually after you reach age 59 1/2.

Are my 401(k) contributions deducted as a percentage of all the pay I receive, including bonuses and overtime?

Workers who are eligible for bonuses and overtime often wonder if their 401(k) contributions will be deducted from all the pay the receive or simply from their "straight" salary base. There is no consistent answer because the rules are set by each employer. Under federal law, you cannot make 401(k) contributions or receive employer contributions for any compensation you earn in excess of $170,000 (in 2001). "As for the vast majority of us who don’t have that problem," says "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "the rules vary from one plan to another. In some plans, the employer takes a percentage of all your compensation when deducting your 401(k) contribution. In others, he’ll count only your base pay. Ask your human resources or personnel department which rule applies at your company."

What’s the minimum I can put in my 401(k)?

While the government places a limit on the maximum amount you can contribute to a 401(k) retirement plan every year, it does not set a minimum. This flexibility allows you to make the maximum contribution in years when you have extra cash and cut back in years when your budget is tight.

What is the limit on investing in a 401(k) every year?

In 2001, the maximum pre-tax 401(k) contribution is the lesser of $10,500 or 25% of your gross compensation. (The maximum is indexed for inflation and adjusted each year.) Also, the 25% contribution limit includes all contributions to the plan such as, your deferrals, employer match employer non-elective contributions, forfeitures allocated to your account and your after-tax contributions. In 2002, the 25% limit will become 100%.

I’ve heard that if I earn over a certain amount, my 401(k) contributions are capped. Is that true, and if so, why?

Your contributions to a 401(k) can be limited, or "capped," if the federal government considers you a highly paid employee. According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "What’s their idea of highly paid? In general, it’s anyone who earns more than $85,000 a year in 2001. The reason for this distinction is that the government wants to make sure everybody benefits equally from the 401(k) plan -- that it’s not just an investment vehicle for higher-paid employees. One of several federal non-discrimination rules prevents highly paid people from saving a substantially greater percentage of their salary in the 401(k) than lower-paid people do. Your company’s plan must pass annual non-discrimination tests after the plan year ends. If there’s too big a gap between highly paid employee contributions and lower-paid employee contributions, the plan has to make an adjustment. It can either refund part of the contribution made by the highly paid employees, or the employer can make a special additional contribution to lower-paid employees’ accounts."

What is the difference between 401(k) and non-401(k) contributions to my account?

The Internal Revenue Code sets a maximum annual limit on the amount of money you can contribute to a 401(k) each year. The amount is indexed each year in step with the Consumer Price Index. Any money you invest in the plan that exceeds the limit is considered an after-tax contribution. According to "Wealth Enhancement & Preservation" (The Institute Inc., Denver), "When you take a distribution from your plan, these after-tax contributions are given to you in a separate check which should not be rolled over into an IRA, as taxes on these monies were previously paid. In fact, if you rolled these monies into an IRA, a substantial penalty would be incurred."

How do my 401(k) contributions lower my income taxes?

Contributions to a 401(k) reduce your income taxes because the amount you contribute isn’t reported as income on you W-2 form to the Internal Revenue Service. According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "The important thing about this tax break is that it makes 401(k) contributions much more affordable: Let’s say Kate earns $25,000 a year. Her marginal federal tax rate is 28%, and her state and local taxes add up to another 4% for a total 32% tax rate. Kate contributes $1,000 a year to the 401(k) plan. That reduces her taxable salary to $24,000 a year. But it also cuts her income taxes by $320 (32% of $1,000)."

After I’ve made the maximum pre-tax contribution allowed, can I put additional money into the 401(k) plan if I want to?

Most 401(k) plans allow workers to make only pre-tax contributions. Other plans allow you to make both pre-tax and after-tax contributions. Most of these plans are older savings programs that were converted to a 401(k) plan after 401(k)s were introduced back in 1978. An after-tax contribution won’t reduce your taxable income. But its earnings in the 401(k) plan will grow, tax-deferred, until you withdraw them.

What are the differences between a pre-tax and an after-tax 401(k) contribution?

Perhaps the most important difference between a pre-tax and an after-tax contribution to a 401(k) plan (or any other retirement plan) is that an after-tax contribution won’t reduce your annual income tax bill. However, like a pre-tax contribution, an after-tax contribution will grow tax-deferred inside the 401(k) until you take the money out. If your company makes matching contributions to your 401(k), it will probably only match your pre-tax contributions. According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "The main thing to understand is that eventually, everything is taxable. The big difference between pre-tax and after-tax contributions is when the tax falls due. Uncle Sam only gets to take one bite of the apple. You have to pay taxes sooner or later, but not both sooner and later. Pre-tax contributions are taxable when you take them out of the plan because they weren’t taxed when they went in. If you take them out before you reach age 59 1/2, you’ll also owe a 10% early withdrawal penalty unless you qualify for a special hardship withdrawal. After-tax contributions can be made to a 401(k) plan if the plan allows them. Because you’ve already paid taxes on this money, you won’t owe additional taxes on it when you take it out of the plan. But when you withdraw after-tax contributions you made after 1986 you must, at the same time, withdraw a proportionate share of the interest they earned. That interest is subject to income taxes and to an early withdrawal penalty if you’re under 59 1/2."

Should I make both the maximum allowable pre-tax and after-tax contributions to my 401(k) every year?

If you have a 401(k) retirement plan, you should always make the maximum allowable pre-tax contribution. The contribution will lower your taxable income, and will grow-tax-free inside the plan until you start making withdrawals. As long as you’re not suffering any cash-flow problems, you should make the maximum allowable after-tax contribution as well. Although after-tax contributions don’t help reduce your annual income tax bill, they still grow tax-free until withdrawals begin. And if you ever need to access the cash before you retire, you may be able to borrow against the built-up equity of your 401(k)-a privilege that Individual Retirement Accounts (IRAs) and many other savings plans do not grant.

Do I have to pay Social Security taxes on the money I contribute to the 401(k) plan?

Many 401(k) investors mistakenly believe that the money they contribute to the plan isn’t taxed at all. But contributions are not exempt from Social Security taxes. For example, if you contribute $2,000 to a 401(k), you will pay Social Security taxes on the entire amount unless you have already paid the maximum Social Security taxes for the year. The silver lining is that your Social Security benefits won’t be reduced by your participation in a 401(k). Of course, one of the great things about contributing to a 401(k) is that the money you contribute will be exempt from federal income taxes. It will also be exempt from any state taxes, unless you live in Pennsylvania. Contributions are also exempt from local taxes in many municipalities.

Do I pay any taxes at all on the pre-tax contributions I make to my 401(k) plan?

Pre-tax contributions you make to a 401(k) retirement plan are not taxable on your annual federal and state income tax returns. So, if you earn $50,000 but put $4,500 of it into the 401(k), you will only owe federal and state taxes on $45,500. However, pre-tax contributions are subject to Social Security taxes. So, the full $50,000 would be taxed by the Social Security Administration.

Does the law allow me to deduct contributions I make to my 401(k) retirement plan?

The Taxpayer Relief Act of 1997 did not change the rules concerning the deductibility of contributions to a 401(k). Although contributions to some types of individual retirement accounts (IRAs) can be deducted, contributions to a 401(k) plan cannot. It is important to note, however, that most people who contribute to an employer-sponsored 401(k) plan make those contributions on a pre-tax basis. Such contributions lower the taxpayer’s adjusted gross income, which means they don’t have to pay taxes currently on the money they put into the 401(k). The taxes are deferred until the money is withdrawn. For example, a taxpayer who earns $50,000 this year but contributes $2,500 of it on a pre-tax basis to the employer’s 401(k) would owe income taxes on just $47,500 of his or her income.

What is a matching contribution to a 401(k)?

Many employers who make a voluntary contribution to their worker’s 401(k) plans do so on a "matching" basis. For example, for every $1 you contribute to your plan, the company might agree to add 25 or 50 cents. But there’s a ceiling on their generosity: most companies will stop matching once you have contributed 3 percent to 6 percent of your own salary to the plan. As an example, say you earn $40,000 and your employer offers a 50 cent match for the first 6% of pay you contribute to the plan. That means that if you make the full $2,400 annual 401(k) contribution, your employer will add an extra $1,200. That’s the equivalent of a guaranteed, risk-free 50 percent return on your investment-a proposition that you’re not likely to find elsewhere.

What is a profit-sharing contribution to a 401(k)?

Some 401(k) plans have provisions that require non-elective or "profit sharing" contributions from the employer as well as the more common matching contributions that are based on the amounts contributed to the plan by employees. Profit-sharing contributions are allocated to the accounts of all the eligible employees, whether or not they defer any of their compensation to make contributions to the plan. Matching contributions are allocated only to those participants who defer into the plan.

Why do employers contribute to 401(k) plans if they don’t have to?

According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), many companies contribute to their own 401(k) plans to "stay competitive with other employers and make sure that talented people think of their companies as good places to work. Employers want to attract and retain valuable employees and a 401(k) plan is a very popular and visible employee benefit. They also want their workers to be able to retire with enough money to maintain a comfortable standard of living. When a company’s former employees live comfortably in retirement, its image is enhanced with shareholders and customers, as well as with current and prospective employees."

Do my employer’s contributions go into the 401(k) plan at the same time as mine?

If you’re a salaried worker who has a 401(k) plan, your contributions to the plan are probably deducted directly from each paycheck- regardless of whether you are paid on a weekly, biweekly or monthly basis. If your employer matches your contributions, it doesn’t have to follow the same schedule. According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "Some employers put matching contributions into the plan along with employee contributions. Others add their match monthly, quarterly or annually. Depending on the company’s annual profits, some employers also offer a 401(k) bonus contribution. The basic match may be 50 cents for example, but the company might add up to 50 cents more in a good year. If applicable, typically the bonus will be contributed in a lump sum after the end of the year."

Can my employer contribute company stock to my 401(k) plan using a an ESOP?

While many companies make cash contributions to their employee’s 401(k) plans, others make their matching contribution in company stock. The stock may be contributed to the 401(k) or added to the company’s Employee Stock Ownership Plan (ESOP) instead of adding cash to the 401(k) plan. Workers can’t sell the stock they own in an ESOP. Instead, they receive its value in cash or in shares when they leave the company or retire.

My spouse and I are both eligible to participate in 401(k) plans at work. We can’t afford to put the maximum contribution into both plans. How do we decide how much to put into each plan?

If you’re married and both you and your spouse are eligible to participate in a 401(k), it would be wise for each of you to make the maximum allowable contribution to each plan. But if you’re like many married couples, you probably can’t afford it. Deciding how much to put into each plan involves four key factors.

1. The amount of each employer’s matching contribution (if any).
2. How soon each of you will be fully vested in those matching contributions.
3. How much you like the investment choices available in each plan.
4. Which plan allows you to borrow money if you’re likely to need a loan.

According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "All things being equal, you should make the maximum contribution to the 401(k) plan with the higher matching contribution. But all things may not be equal. Perhaps one of you is less likely to stay with his or her present employer long enough to become fully vested; it may make more sense to opt for a plan that has a lower matching contribution if you’re a lot likelier to become vested in that employer’s matching contribution. One plan may feature a greater range of investment choices than the other one, or may include investments that have performed better. "Finally, consider whether or not you can borrow from your 401(k) account. Not all 401(k) plans allow you to do to this. If you anticipate that you’ll need to borrow from your retirement nest egg to cover a major expense -- the cost of a college tuition or a down payment on a house -- a loan feature could be the determining factor in choosing one 401(k) plan over the other."

Can I stop contributing to my 401(k) account if my budget is tight and I can’t afford to save the money?

Most 401(k) plans will allow you to stop contributing to the plan at any time. However, there’s no legal requirement to allow this. Ultimately, it’s a decision that’s in the hands of the plan’s administrators. Some plans lock each participant into a specific contribution for a full year. If you’re not sure what the rules are, contact your employer’s human resources or personnel department.

Can I take my money out of my 401(k) plan if I stop contributing to it?

According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "The fact that you’re no longer contributing to the plan doesn’t mean you can start taking withdrawals. There are only three ways to take money out of your 401(k) account: distributions, early withdrawals and loans. You can take distributions after age 59 1/2 when you leave your job; you can take early withdrawals only for reasons specifically approved by the Internal Revenue Service and the plan. Whether or not you can take a an early distribution or a plan loan depends on your plan’s rules."

Who picks the investment manager for my company’s 401(k) plan?

Every 401(k) plan has a plan trustee who is legally responsible for choosing the company (or companies) that will invest the money contributed to the 401(k) program. Federal law requires that this choice be based solely on the "best interest" of the plan participants-you and your fellow workers. The trustee is also responsible for monitoring the investment managers’ performance.

Who picks the 401(k) plan investments?

Technically, the employer who provides a 401(k) plan is responsible for deciding which type of investments the plan will offer. However, employers rarely make this decision by themselves. Instead, they get help from a professional firm that specializes in 401(k) plans. Once your employer decides which types of investments the 401(k) should offer, you get to choose how you want your own contributions allocated.

How many investment options must be offered in a 401(k) plan?

Technically, there is no minimum or maximum number of investment options that an employer must offer in its 401(k) plan. It may offer just one or two investment choices, or more than a dozen. If you don’t like those choices, you can ask the company to expand its selections. Or, you can set up an Individual Retirement Account (IRA) or similar plan to start building a nest egg yourself. The U.S. Department of Labor has established a list of voluntary guidelines, commonly called 404(c) regulations, that encourage employers to offer at least three different investment choices in their 401(k)s. The key word here is voluntary. Employers are not legally required to follow these guidelines, or even offer a 401(k) at all.

How often can I switch money among investments in my 401(k)?

How often you can switch among 401(k) investments is determined by the rules that govern your company’s plan. Most plans allow switching either once a month, once a quarter or twice a year. A few plans allow switching daily, and others only once a year. There’s no legal requirement your employer must follow when determining how often switches can be made. However, employers who have chosen to follow the Labor Department’s voluntary 404(c) regulations must give participants the opportunity to move their money among investment funds at least quarterly, and more frequent transfers must be permitted in instances where the plan offers unusually volatile investments. Perhaps the main reason why companies put limits on the frequencies of transfers in a 401(k) is that each transfer raises the cost of operating the plan. Most experts say it’s foolish for investors to make frequent trades inside their accounts. After all, the primary goal of most 401(k) investors is to achieve slow but steady growth over the years, not to make frequent trades in an attempt to out-guess the market.

Do I get to decide how to invest all the money in my 401(k) account?

You always get to decide how your own contributions to a 401(k) are invested. The only restriction is that the money must be placed in the group of investments that your employer has decided to offer. Most 401(k)s offer several investment options, including a variety of mutual funds and, quite often, guaranteed investment contracts that provide a fixed rate of return. However, if you want to invest in something that’s not offered through the plan, you will have to make the investment outside of your 401(k). Still, all of the money in your 401(k) won’t necessarily be invested according to your own wishes. Many companies that match an employee’s contribution with a contribution of their own insist that the company’s contribution be put into the company’s own stock. So, just as you have the right to invest your own 401(k) money as you wish, the company has the right to choose how its matching funds will be invested on your behalf.

What can I do if I don’t like my 401(k) plan’s investment options?

An employer has the right to decide what type of investments that its 401(k) plan will offer. As a plan participant, you get to choose from this investment menu when deciding how your contributions to the plan will be allocated. If you don’t like the investment options that your 401(k) provides, talk to your company’s human resources or personnel department about changing them. Your employer wants its 401(k) plan to be attractive, so it should welcome suggestions about alternative investment options from its workers. Of course, you can’t expect the company to change the plan’s menu of investments simply to suit you. If several employees express an interest in, say, an international mutual fund, there’s a good chance that it will be added to the 401(k) plan’s list of investment options. But if you have some bizarre desire to buy and sell raccoon-pelt futures, don’t expect the company to restructure its plan to accommodate your unusual impulse.

What are the advantages and disadvantages of owning company stock in my 401(k) account?

Many 401(k) plans allow you to invest some or all of your contributions to the plan in the company’s own stock. In addition, some employers give their matching contribution in company stock rather than in cash. Buying stock in your own company through your 401(k) offers some clear advantages -- and disadvantages too. On the bright side, you probably know more about the company you work for -- its strengths, weaknesses and growth prospects -- than any other. As an "insider," you probably have a good idea of whether it’s on the upswing or its best days are behind it. But it’s risky to have both your paycheck and retirement nest egg riding on the success of a single company, no matter how bright its future. If the company runs into trouble, you could lose your job and your retirement fund could suffer if the value of the stock falls. According to "Building Your Nest Egg with Your 401(k)" (American Press Inc., Washington Depot, Conn.), "If you already receive company stock through your employer’s matching contribution, that’s great. But you should carefully evaluate the risk before you increase your investment in the stock by purchasing additional shares for your account."

Why doesn’t my 401(k) plan allow me to transfer money from a GIC fund to a money market fund?

Two of the most conservative investments offered in many 401(k) plans are guaranteed investment contract funds and money market funds. Guaranteed investment contracts (GICs) are issued by an insurance company and sold only to pension and other retirement plans. They pay a fixed interest rate for a fixed term, typically one to five years. Many 401(k) plans offer a GIC fund -- often called a stable value fund or an insurance contract fund -- which buys GICs from many different insurers. A money market fund invests in relatively short-term financial instruments, such as Treasuries and bank certificates of deposits. Rates on money market funds are usually lower than on GICs because money market investors don’t want to keep their cash tied up for long periods of time. Many 401(k) plans prohibit transfers from a GIC fund to a money market fund because the fixed rate earned on a GIC is conditional on leaving the money invested for the term of the contract. If GIC fund investors could cash out early when interest rates go up, the fund might be forced to sell its long-term investments at a loss to pay the investors their money.

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