qualified retirement plan

Avoid Awkwardness in the Afterlife–Confirm Your Beneficiary Designations

May 24th, 2013

This is a topic that I cover with all clients, and one that I recommend you for everyone with retirement plans and other accounts with beneficiary designations. Too often we think we have the beneficiary designation form filled out just the way we want it, and then (once it’s too late) it is discovered that the form hadn’t been updated recently – and the designation is not what we hoped for.

I made this recommendation to a client not long ago. He assured me that he had all of his designations set up just the way he wanted. His wife, sitting next to him in our meeting, asked him to make sure – talk to the IRA custodian and get a copy of the designation as it stands today. A bit miffed about it all, he agreed to do so, and did the next day. Guess what he found – as it stood on that day, his IRA beneficiary designation form indicated 100% of his IRA would pass to his ex-wife from 15 years ago! Plus, he had no secondary beneficiaries named, which meant that if the ex predeceased him, HER heirs would be the primaries. Thankfully he had checked on this to avoid this awkward and possibly devastating situation.

Know what was fixed pretty much immediately?

Take the time

You owe it to yourself and your heirs to take the time to review your beneficiary designations and keep copies of them in your “dead file”. This includes IRAs, Roth IRAs, 401(k)/403(b)/457 plans, and other pensions or retirement plans. You also may have POD or TOD (Pay on Death or Transfer on Death) designations on non-retirement accounts – confirm these and keep copies as well.

For your standard retirement accounts, such as IRAs, 401(k)s and the like, you typically have the option of naming a primary beneficiary (or beneficiaries) and a secondary or contingent beneficiary or beneficiaries. It makes a huge difference on these accounts that you name a specific person (or persons) as the primary beneficiary, and a specific person (or persons) as the contingent beneficiary. With IRAs, if you leave the designation blank, you may be taking away important options for your heirs.

If you leave the primary beneficiary designation blank you are leaving the transfer of your IRA up to the custodian’s default designation. Quick! What’s your IRA custodian’s default beneficiary designation?? I didn’t think you’d know.

Often this default is your spouse first, and then your “issue” – meaning your children and other descendants. Other times, the default beneficiary is your estate. In the event that the estate is the default beneficiary, any beneficiaries of the estate will receive the IRA, but they will not be able to utilize the “stretch” option of receiving payout of the account over their remaining lifetimes. This is because the IRS rules state that a “named beneficiary” must be in place in order to use the stretch provision. If no “named beneficiary” exists, the stretch option is not allowed. If the default is your spouse and your issue, these can be treated as “named beneficiary” if they are alive.

Discuss with your heirs

At face value, even though you think your intent for your beneficiary designations is clear, it might not be clear to your heirs. For example, you may have chosen to pass along half of your IRA to your youngest child and only a quarter to the older two children because you believe the youngest child can use the money more than the other two. Or maybe you decided to leave the entire IRA to your oldest daughter, and you want to designate your three sons to split up the farmland – which you believe is an equitable division.

Whatever you’ve decided, especially if there are perceived inequities in your division plan, you should take the time to review your plan with your heirs. If that makes you uncomfortable, there are a couple of things to consider: First, if you’re uncomfortable discussing it with them, imagine how uncomfortable your heirs may be when the time comes to distribute your estate. Maybe it’s not such a good idea after all if it could cause contention among your heirs. Second, if you still believe your split is the right way to go, you should explain your plan to someone – your designated executor would be a good choice. And the designated executor should be a disinterested separate party, someone who isn’t receiving benefit from your estate plan, in order to keep the process “clean”. Otherwise, if one of the heirs is your executor and the executor is perceived to receive preferential treatment, again you’ll have some contention among your heirs.

If there are complex instructions involved, consider making an addendum to your will. Instructions in your will would have no impact on the beneficiary designations on your IRAs and other plans (these pass outside of your estate as long as you’ve made specific designations) but other asset divisions aside from retirement accounts may require explanation for your heirs to understand your intent. Don’t expect that everyone will understand or agree with your thought process when you’re gone. Explaining your thought process in advance will likely help to ensure that your division plan doesn’t result in a family rift.

Take the time to review your beneficiary designations. Make sure that you have the primary beneficiary or beneficiaries that you want, and the percentages that you’d like each to have. Also make sure that you have named contingent beneficiary or beneficiaries in the event that your primaries have predeceased you. Lastly, make sure that you note how division is done after the death of the beneficiaries: per stirpes or per capita.

Your Employer’s Retirement Plan

Mar 13th, 2013

by sraskie.

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Whether you work as a doctor, teacher, office administrator, attorney, or government employee chances are you have access to your employer’s retirement plan such as a 401(k), 403(b), 457, SEP, or SIMPLE. These plans are a great resource to save money into, and some employers will even pay you to participate!

Let’s start with the 401(k). A 401(k) is a savings plan that is started by your employer to encourage both owners of the business and employees to save for retirement. Depending on how much you want to save, you can choose to have a specific dollar amount or percentage of your gross pay directed to your 401(k) account. Your money in your account can be invested tax-deferred in stock or bond mutual funds, company stock (if you work for a publicly traded company), or even a money market account. Your choice of funds will depend on the company that offers the 401(k) through your employer. Generally, you’re going to want to choose funds with low fees and expenses. As of 2013, the maximum amount you can put into your 401(k) is $17,500 annually and another $5,500 “catch-up” contribution if you’re age 50 or older. At age 59 ½ qualified withdrawals are now taxed as ordinary income. Withdrawals before age 59 ½ are subject to penalties with some exceptions.

A cousin to the 401(k) is the 403(b). The 403(b) is very similar to the 401(k) in that you’re allowed to allocate a certain amount or percentage of your gross pay to your account, tax-deferred. Where the 403(b) differs is that it’s only allowed for non-profits such as school districts, hospitals, municipalities, and qualified charitable organizations. Another difference is by law the money in your 403(b) can only be invested in mutual funds or annuity contracts. You’re not allowed to own individual stocks or bonds in it. Like the 401(k), you’re allowed to save (as of 2013) $17,500 annually and another $5,500 “catch-up” contribution if you’re age 50 or older. At age 59 ½ qualified withdrawals are now taxed as ordinary income. Withdrawals before age 59 ½ are subject to penalties with some exceptions.

Branching out in our retirement plan family tree we come to the 457 plan. 457 plans are reserved for certain non-profits such as hospitals, government entities, school districts and colleges and universities. As you may have guessed, 457 plans are similar to their 401(k) and 403(b) counterparts in that money from your gross pay goes into your account tax-deferred. Like the 403(b) the 457 only allows investments in mutual funds or annuity contracts.

Similar to the 401(k) and 403(b), you’re allowed to save up to $17,500 annually and another $5,500 “catch-up” contribution if you’re age 50 or older (for 2013). Unlike the 401(k) and 403(b) the 457 allows you access to your money at any age, as long as you’re separated from service from your employer. For example, if you were 40 years old and have been saving into a 457 since you were age 25 and you saved $50,000 and you were fired, laid off or resigned, you’d have access to your 457 money without penalty; you’d simply pay ordinary income tax on any withdrawals.

Another key point to make is in regards to the aggregation rule. What this means is that you’re only allowed to invest $17,500 (along with the “catch-up” if you qualify) total between a 401(k) and a 403(b). For example, you work as a professor for nine months of the year and save $14,000 in your college’s 403(b). Over the summer, you work part time for a company that offers a 401(k) plan and you want to save money there. Assuming you’re age 40, you’d only be able to save an additional $3,500 to your summer company’s 401(k) – for a total of $17,500.

There is one exception to the aggregation rule. If you have access to a 401(k) or 403(b) and a 457, you are allowed to contribute the maximum to the 401(k) or 403(b) – for a total of $17,500 and then contribute the maximum to the 457 for an annual total of $35,000. The 457 trumps the aggregation rule. Few people may be able to actually sock away $35,000 per year, but it is available to those that work for employers offering both plans or if you work for two or more employers and they offer one or the other.

SEPs and SIMPLEs work a bit different. Typically these plans are available to smaller employers and SEPs are common for those that are self-employed. Both SEPs and SIMPLEs use IRAs as the funding vehicle to place retirement money, but each has different requirements as to contribution limits and participation requirements.

SEPs (Simplified Employee Pensions) can be funded to a maximum of $51,000 annually (for 2013) or 25% of the employee’s salary – whichever is smaller. There can be corresponding tax deductions involved that may be beneficial for solo businesses or businesses with a small number of employees as there are requirements that all employees must participate.

SIMPLEs (Savings Incentive Match PLan for Employees) are another option for smaller businesses looking to start a retirement plan and looking for a cost effective way to start (a 401(k) can be administratively expensive). Essentially, both employer and employees are allowed to participate and certain rules dictate that the employer must make a matching contribution (hence the Match in the name) to participating employees. As of 2013 you can contribute a maximum of $12,000 annually to a SIMPLE plan with an additional “catch-up” contribution of $2,500 if you’re age 50 or older.

The aggregation rule that applies to the 401(k) and 403(b) also applies to SEPs and SIMPLEs. This means that of the four plans for 2013, you’re still only allowed a total contribution of $17,500 annually ($23,000 if you’re age 50 or over). Having a 457 would be the only way to increase this amount.

Like SEPs and SIMPLEs, some 401(k) and 403(b) plans also have the company match. This means that in addition to your contributions, your employer will also make a contribution or “match” to the amount you’re contributing up to a certain percent. Consider taking full advantage of this. It’s free money! There are several reasons why an employer would do this ranging from plan compliance to helping ensure employee satisfaction and loyalty.

Finally, participating in your employer’s plan does not prohibit you from participating in a Traditional or Roth IRA. You are allowed to contribute the maximum allowed by law to both your employer’s plan and your own IRA.

It goes without saying that before you decide to participate, talk with your human resources department (not your cubicle buddy) or a financial professional regarding your options and which option or combination is right for you.

Rolling Over a 401(k) into a New Employer’s Plan

Feb 20th, 2013

by jblankenship.

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When you change jobs you have a choice to make regarding your retirement plan at former employer. If the plan is a 401(k), 403(b), or other qualified plan of that nature, you may have the option to roll the old plan into a plan at your new employer.

The new employer’s plan must allow rollovers into the plan – this isn’t always automatic. Most plans will allow rollover of former employer’s plans, but not all. Once you’ve determined that the plan will accept a rollover, you should review the new plan to understand whether or not it makes sense to roll your old plan into it, or choose another option. Other options may be: rollover the old plan into an IRA, convert the old plan to a Roth IRA, leave the old plan where it is, or take a distribution from the old plan in cash.

In this article we’ll just deal with rolling over the old plan to your new plan.

If the new plan has some compelling features, such as access to very low cost institutional investments or attractive closed investment options, or if the plan has very low overhead and great flexibility, you might want to rollover your old plan into it. Other reasons that might compel you to rollover the old plan might be – to have access to loan features (IRAs don’t have this), access to your funds when leaving your employer after age 55 but before age 59½, and ERISA protection against creditors.

There may be reasons to leave your old plan at the old employer though. The two that come to mind are NUA treatment of stock of the old employer, and if you think you’ll need access to the funds before you leave the new employer (especially if you’ve left that employer after age 55).

So after reviewing the options and features, you’ve decided to rollover the old plan to the new employer’s plan. It’s a relatively straightforward process: you contact the old plan’s administrator and request a rollover distribution form. You should have already contacted the new plan’s administrator to ensure that the new plan will accept a rollover. Once you have the rollover distribution form from the old employer, get any pertinent information from the new employer, such as your employee id, or an account number for the new plan.

On the rollover distribution form, you’ll have the option to send the distribution directly to the new plan – called a trustee-to-trustee transfer. In this manner, the funds never come into your possession. This is important, because if you take distribution in cash from the old plan, the IRS requires that 20% is automatically withheld from the distribution. You could still send the distribution to the new plan – but you’d have to come up with the 20% that was withheld in order to make the transfer “whole”. It’s not required that you make a complete transfer, but if you take any of the funds in cash, including the withheld 20%, this money will be taxable as ordinary income, and if you’re under age 59½ it will likely also be subject to an additional 10% penalty.

After all of this has occurred, your new plan will have the additional old plan money rolled into the account. Most likely this will be entirely in cash when it arrives in the account – so you will need to make investment allocation choices for the new addition to the account.

Pros and Cons of the Roth 401(k)

Feb 13th, 2013

by jblankenship.

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The Roth 401(k) first became available in January 2006, is an option available for employers to provide as a part of “normal” 401(k) plans, either existing or new. The Roth provision allows the employee to choose to direct all or part of his or her salary deferrals into the 401(k) plan to a separate account, called a Designated Roth Account, or DRAC.

The DRAC account is segregated from the regular 401(k) account, because of the way the funds are treated. When you direct a portion of your salary into a DRAC, you pay tax on the deferred salary just the same as if you had received it in cash. This deferred salary is subject to ordinary income tax, Medicare withholding, and Social Security withholding if applicable.

The unique thing about your DRAC funds is that, upon withdrawal for a qualified purpose (e.g., after you have reached age 59½, among other purposes) the growth that has occurred in the account is not subject to tax. If this sounds familiar, it’s because this is the same type of tax treatment that is applied to a Roth IRA. Conversely, the regular 401(k) growth and contributions are subject to ordinary income tax upon withdrawal – just the same as a regular (non-Roth) IRA.

Pros of a Roth 401(k)

Among the positive aspects of a Roth 401(k) versus a regular 401(k) are:

Future taxation is eliminated (for qualified purposes). Growth and contributions are tax-free when withdrawn after age 59½.
Concerns over future tax rates are eliminated since you’ve already paid the tax on your contributions. If the future tax rates are greater you’d pay the higher rates on regular 401(k) distributions – no tax is due on qualified Roth 401(k) distributions.
Contributions could be withdrawn tax-free, with restrictions, prior to age 59½ – after you have left the employer.
Early distribution options for education, home down payment, or medical expenses are not available for a DRAC as they are from a regular 401(k).

Benefits of a Roth 401(k) versus a Roth IRA:

Higher contribution amounts for the Roth 401(k) – up to $23,000 in 2013, versus $6,500 for a Roth IRA (catch-up contributions have been included, the maximums are $17,500 and $5,500 if under age 50).
Employer matching contributions are available, although these must be directed to a “regular” 401(k) account, not the DRAC.
Income restrictions that are applied to Roth IRA contributions are more-or-less eliminated with the DRAC.
Contributions can be made to the account after reaching age 70½ if still employed and not a 5% or greater owner of the employer.
Loans may be available against the balance in the Roth 401(k) account while still employed, if allowed by the plan administrator.

Cons of a Roth 401(k)

Negative aspects of a Roth 401(k) compared to a regular 401(k):

You must pay tax on the salary deferred into the DRAC, whereas deferrals to a regular 401(k) are not subject to ordinary income tax.
If tax rates are lower for you in retirement, you have paid a higher rate on the contributions to the account, although the growth is still tax free for qualified withdrawals.

When comparing a Roth 401(k) to a Roth IRA, the following downsides are evident:

Upon reaching age 70½ your DRAC account will be subject to Required Minimum Distributions, just like a regular 401(k) or IRA. This can be mitigated by rolling over the Roth 401(k) to a Roth IRA upon leaving the employer.
You can’t access the contributions to the DRAC before you leave employment, while you can always have access to the contributions to a Roth IRA account.

Decision-point

The decision of whether to participate in a Roth 401(k) if your employer provides one is primarily the same as the decision-point of contributing to a Roth IRA versus a regular IRA. Actually, the decision between the two types of IRA is a bit more complicated due to restrictions on income levels and deductibility, which don’t apply here. The primary questions that need to be asked are:

Can you afford the tax on the maximum contribution to a Roth 401(k) account?
Do you think the tax rates will be higher or lower when you reach retirement age?

Affordability

If you can’t afford to pay the additional tax on the deferred salary (as compared to when you place the money in a regular 401(k)), then it would probably be better to choose the regular 401(k).

For example, if you’re in the 25% tax bracket deferring the maximum $23,000 into a regular 401(k) will reduce your taxes by $5,750 – and so if you chose the DRAC instead, you’d have to pay that much more in tax. If this kind of additional tax will have a negative impact on being able to pay your day-to-day expenses, the Roth 401(k) is probably not a good option for you.

Keep in mind that the decision isn’t all-or-nothing: you could choose to direct a portion of your deferral to Roth 401(k) and the remainder to the regular 401(k), which would allow you to manage the amount of extra tax that you pay.

Future Tax Rates

If you believe that the future tax rates will be greater than they are for you now, it will be to your advantage to use the Roth 401(k) – so that you pay tax at the lower rate now and avoid the future higher rate. On the other hand, if you believe that the rates will be lower for you in the future, deferring tax on regular (non-Roth) 401(k) contributions will be more to your advantage.

How Dollar-Cost-Averaging Can Work to Your Advantage for Your 401(k)

Feb 6th, 2013

by jblankenship.

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When you invest in your 401(k) plan with salary deferrals from each and every paycheck, you are taking part in a process known as Dollar-Cost-Averaging (DCA). This process can be advantageous when investing periodically over a long span of time, by smoothing out the volatility of the market and giving you an average cost of your investment shares over time.

How does this work, and how can it be advantageous?

Dollar-Cost-Averaging

When deferring income with each paycheck, typically you will be investing in your 401(k) plan each pay period, whether monthly, bi-weekly, or weekly. Each pay period the same amount is deferred and invested, no matter what the price of the underlying investments are at the time. Since you’re always putting the same amount into the investment, when the price of the shares is higher, you purchase fewer shares; when the price is lower, you are purchasing more shares.

Note: DCA can be used with any type of investment account, including a 401(k), 403(b), IRA, or even a non-tax-deferred investment account. We’ll refer to 401(k) accounts throughout the article since this is one of the more common accounts where DCA is employed.

For example, let’s say that you defer $100 every two weeks into your 401(k) plan, and your investment is an index fund. For the first pay period the price of the fund is $10. When you make your deferral and purchase this time, your $100 purchases 10 shares.

Then, in the next pay period the price of the shares of your index fund has increased to $10.50. Now your $100 purchases 9.5238 shares, and you have a total of 19.5238 shares, at a price of $10.50 per share, for a total account value of $205.

On the following pay period the price of your index fund has fallen to $9.50 per share. Your $100 deferred will purchase 10.5263 shares of the fund – you now have a total of 30.0501 shares at a price of $9.50, with a total account value of $285.48.

The table below plays out purchases with random amounts over a year and then tallies the result:

Pay Period	Amount Deferred	Price Per Share	Shares Purchased	Total Shares	Total Value
1	$100	$10.55	9.4787	9.4787	$100.00
2	$100	$10.44	9.5785	19.0572	$198.96
3	$100	$9.92	10.0806	29.1378	$289.05
4	$100	$10.33	9.6805	38.8183	$400.99
5	$100	$11.95	8.3682	47.1865	$563.88
6	$100	$11.36	8.8028	55.9893	$636.04
7	$100	$9.14	10.9409	66.9302	$611.74
8	$100	$9.54	10.4822	77.4124	$738.51
9	$100	$11.67	8.569	85.9814	$1003.40
10	$100	$9.76	10.2459	96.2273	$939.18
11	$100	$10.46	9.5602	105.7875	$1106.54
12	$100	$9.62	10.395	116.1825	$1117.68
13	$100	$10.23	9.7752	125.9577	$1288.55
14	$100	$10.70	9.3458	135.3035	$1447.75
15	$100	$10.40	9.6154	144.9189	$1507.16
16	$100	$11.52	8.6806	153.5995	$1769.47
17	$100	$11.37	8.7951	162.3946	$1846.43
18	$100	$10.91	9.1659	171.5605	$1871.73
19	$100	$11.55	8.658	180.2185	$2081.52
20	$100	$10.37	9.6432	189.8617	$1968.87
21	$100	$10.19	9.8135	199.6752	$2034.69
22	$100	$9.98	10.02	209.6952	$2092.76
23	$100	$11.89	8.4104	218.1056	$2593.28
24	$100	$11.82	8.4602	226.5658	$2678.01
25	$100	$10.33	9.6805	236.2463	$2440.42
26	$100	$11.41	8.7642	245.0105	$2795.57

The table above was created by generating random prices between $9 and $11.99 over the 26 periods. In real life, your investment wouldn’t likely have such wildly-fluctuating values during the course of 26 pay periods – I used this degree of fluctuation to demonstrate the benefit of DCA when the investment is relatively volatile.

The Advantage

If, instead of investing $100 every two weeks you saved up the entire $2600 and invested it at the end of the 26th pay period, you would be purchasing all of the shares at $11.41, for a total of 227.8703 shares. By DCA, your $2600 has increased in value such that you hold 245.0105 shares, with a value of $2795.57 – a net benefit of $195.57.

On the other hand, if you had $2600 to invest at the beginning of the table when the price was $10.55 per share, you would have purchased a total of 246.4455 shares, which would be worth a total of $2811.94 at the end of the 26 periods.

You can see from the table that by Dollar-Cost-Averaging, you achieve an average price per share over the period that is beneficial to you – since you’re purchasing exactly the same dollar amount of shares every time. When the price is high, you buy fewer shares, and when the price is low you buy more shares. By doing this over a long period of time, such as 30 years, you will avoid the risk associated with saving up a large sum of money and (perhaps) purchasing shares in an investment at a relatively high price by comparison over the savings period.

IRAs and Medicaid

Feb 1st, 2013

by sraskie.

4 comments

When it comes to IRAs and Medicaid eligibility the question that gets asked is, “How does my IRA affect my eligibility for Medicaid?”

Many states share similar guidelines when it comes to exempt and non-exempt assets in IRAs. Essentially, it boils down to this: if the IRA is not in payout status (the IRA owner is not taking required minimum distributions) then the assets in the IRA are included (non-exempt) in the determination of eligibility. However, if the IRA is in payout status and the owner is now taking required minimum distributions (RMDs) the total amount of the IRA is not included, but the annual income from the RMDs is.The same would be true regarding 401(k)s, 403(b), and other qualified plans that may require RMDs after age 70 ½.

There are some states (Illinois for example) that treat IRAs, a 401(k), and pensions as exempt. Check your state’s laws to see where you fit in.

Another asset that works similarly is an annuity. Like the IRA, if an individual owns and annuity and it is not in payout status (it hasn’t been annuitized), the entire account balance is deemed non-exempt and it is considered an includible asset. If the annuity has been annuitized and is now rendering a steady stream of guaranteed payments, then the annuity balance is not included, but the annual income from the annuity payments is.

What is a 401(k)?

Jan 23rd, 2013

by jblankenship.

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Many of us have access to a 401(k) plan at our workplace – have you ever wondered exactly what a 401(k) is?

The 401(k) plan is named for a specific section in the Internal Revenue Code – Section 401, subsection k, to be exact. This code section lays out the rules for these retirement plans, which are employer-sponsored plans providing a method for the worker or employee to defer a certain amount of income into a savings plan on a pre-tax basis.

Often the employer also includes a matching contribution to the employee’s account. These matches are typically based upon the amount of contribution that the employee makes to the plan – such as a dollar-for-dollar match for contributions made by the employee up to certain percentage of the employee’s income. The deferred income is not subject to ordinary income tax, but it is still subject to FICA (Social Security) and Medicare taxes. The employer match is not subject to any of these taxes.

The income that the employee voluntarily defers into the 401(k) plan is immediately vested with the employee, meaning that the contributions that the employee makes belongs exclusively to the employee. Employer-matching funds are usually subject to a schedule for vesting. An example would be that the employee must remain employed for a specific period of time (say, five years) before the employer-matching funds are vested with the employee. Leaving employment prior to meeting that vesting schedule could result in the employee relinquishing a portion or all of the employer-matching funds in the account.

The income that is diverted into the 401(k) plan can be allocated to a variety of investment choices. The choices are generally limited to a defined group of stocks and mutual funds by the plan administrator. Lately many plans also offer an option to use a regular brokerage account to provide investment in virtually any domestic holding.

Restrictions

In addition to the restricted group of investments that you may have available to choose from, there are many other restrictions on your 401(k) account. For example, once you divert your income into a 401(k) plan, you generally cannot withdraw the funds from the account while you’re still employed with that employer. Some plans do have in-service distributions available after the employee has reached a particular age (generally 59½), but this is relatively rare.

After you leave employment you have the option of withdrawing the funds from the account. There are a few ways that this can be done -

A direct rollover to another retirement plan (another 401(k) or an IRA), which is a non-taxable event; or
A cash distribution to you, which will be subject to a mandatory 20% withholding, since this is potentially a taxable event (even if you rollover the distribution to another plan within 60 days); or
A distribution of the securities that you own in the plan. Part of this distribution may be taxable (see this article on NUA, Net Unrealized Appreciation, for more details). The portion of the distribution that is taxable will be subject to the mandatory 20% withholding mentioned above.

If any of these distributions occurs before you reach age 59½ you may be subject to an early distribution penalty of 10% unless you meet one of the exceptions, which includes purchase of a first home and payment of certain medical expenses, among other exceptions.

Loans can be available to access the funds in your account while still employed. The loans are limited to 50% of your total vested account balance, with a maximum loan amount of $50,000. The loan must be paid back over the course of five years, at a prescribed rate of interest. If you leave employment while your loan is still outstanding (at whatever amount), the loan must be paid back immediately, either from outside funds or from funds in the 401(k) account. If the funds are paid back from within the 401(k), what happens is that you will be considered to have withdrawn the amount of the loan from the account, and the withdrawal will be subject to ordinary income tax and possibly a penalty if you are under age 59½ at the time you leave employment.

Contribution Limits

There are certain limits to the amount of contributions (income deferrals) that can be made into a 401(k) account. For 2013, the annual limit for deferral of income is $17,500. There is an additional “catch-up” contribution amount that folks over age 50 can make – up to $5,500.

There is also a maximum amount that can be contributed in total – including the employer match. For 2013 this limit is $51,000, or $56,500 when the catch-up contribution is used.

All of these limits are based upon the employee’s salary, as well. If the employee’s salary is less than the annual maximum contribution limit, then the contributions are limited to 100% of the employee’s salary for the year.

Roth 401(k)

Briefly, there is another type of account that can be included in an employer’s 401(k) plan: the Roth 401(k), which is also known as a Designated Roth Account, or DRAC. The DRAC allows the employee to divert income into the account on an after-tax basis – meaning that money contributed to the DRAC is taxed as if the employee received it in cash. The funds in the DRAC account are subject to the same limitations of withdrawal (while employed) as the “regular” 401(k) account. In return for the pre-payment of tax on these restricted funds, when the employee leaves employment he or she can access these funds tax-free once the employee reaches age 59½.

Wrap up

This article was not intended to cover every nuance of 401(k) plans; rather, it was intended to provide a brief overview of this important part of your retirement plan. We’ll cover more specifics on the 401(k) plan in future articles.

History of the 401(k)

Jan 9th, 2013

by jblankenship.

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Back in 1978, the year of 3 popes, Congress passed the Revenue Act of 1978 which included a provision that became Internal Revenue Code section 401(k).

The 401(k) has roots going back several decades earlier, with many different rulings (Hicks v. US, Revenue Ruling 56-497, and Revenue Ruling 63-180, among others), providing the groundwork for the specialized tax treatment of salary deferrals that Section 401(k) enabled.

More groundwork for the 401(k) as we know it was laid with the passage of the Employee Retirement Income Security Act (ERISA) of 1974, in that the Treasury Department was restricted from putting forth a particular set of regulations that would have reduced or eliminated the tax-deferral benefits of deferred compensation plans. After the Treasury Department withdrew the proposed regulations in 1978, the way was cleared to introduce the 401(k) plan with the Revenue Act.

This particular section of the Code enabled profit-sharing plans to adopt “cash or deferred arrangements”, or CODAs, funded via pre-tax salary deferral contributions. When the 401(k) code section became effective in January 1980, and the IRS proposed the regulations for Section 401(k) in late 1981, the idea came forth to replace existing bonus arrangements with the new tax-deferred alternative. The real “kicker” that caused the 401(k) plan to garner interest by employers was the ability to save on taxes while still maintaining competitiveness with the earlier bonus plans – and the employer matching arrangement of 401(k) plans did just that.

Several large corporations very quickly began replacing after-tax thrift plans with the new 401(k) plan, and adding 401(k) options to existing profit-sharing and stock bonus plans. The new 401(k)-type of plan provided the employee with deferred taxation on funds diverted into the plans, and provided the employers with the ability to make significant matching contributions on a tax-favored basis.

In 1984, the Tax Reform Act of ‘84 enacted rules for “non-discrimination” testing in the 401(k) plans – meaning that highly-compensated employees couldn’t receive benefit from the plans if non-highly-compensated employees weren’t participating in the plans to an allowable degree.

Then the 1986 Tax Reform Act further tightened the non-discrimination restrictions and set the maximum annual allowable amount of deferral of compensation by employees at $7,000. Up to this point, there was only an annual limit on all contributions by both the employer and employee, which was set at $30,000 from 1982 through 2003. These amounts have gradually increased to today’s levels, of $17,500 for regular deferral by employees and a total annual limit of $51,000.

The 20% mandatory withholding requirement for distributions from 401(k) plans was added with the 1992 Unemployment Compensation Amendments. This requirement applies to distributions that are not rolled over into another retirement plan.

In 1996, the passage of the Small Business Job Protection Act provided an additional boost to participation in 401(k) plans with the release of limits on the contributions that could be made to a retirement plan by an employee that is also participating in a regular pension, or defined benefit, plan.

One more piece of legislation that had a great impact on 401(k) plans was the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which bumped up the annual maximum contribution by employers and employees (it had been frozen at $30,000 since 1987), as well as adding the “catch-up” contribution provision. The catch-up contribution provision allows participants who are age 50 or older an additional amount to defer into 401(k) plans annually, not limited by the annual maximum contribution amount. This was set at $3,000 initially and has been indexed by COLA to the 2013 limit of $5,500.

EGTRRA also introduced the Roth 401(k) feature, which allows participants to elect a designated separate account within the 401(k) plan that accepts salary deferrals on an after-tax basis, and then provides for a Roth-IRA-type of treatment for qualified distributions.

After EGTRRA, the Pension Protection Act of 2006 came along, which made permanent the provisions of EGTRRA (originally these were set to expire in 2010), as well as providing methods for employers to automatically enroll employees in the plans and choose default investments. The purpose of these provisions was to bolster participation in 401(k) plans and facilitate the best used of these plans.

Most recently, the 2013 American Taxpayer Relief Act (ATRA) provided a method for converting “regular” 401(k) account funds to Roth 401(k) accounts – previously, a participant in a 401(k) plan could only convert funds from a regular account to a Roth account if he or she was in a position to otherwise distributed funds from the account. Generally this means that the employee/participant has left the job associated with the 401(k) or has reached a retirement age set by the plan administrator. With the new rules provided by ATRA, these conversions could be undertaken by a currently-employed participant of any age.

Receive a Tax Credit For Saving

Dec 19th, 2012

by jblankenship.

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Starting (or staying with) a savings plan can be difficult to do. After all, it’s often difficult enough to just get by on your earnings day-to-day, week-to-week, before reducing the take-home pay that you’ve worked so hard for by putting it into a savings plan. The thing is though, once you start a savings plan, you’ll be surprised at how little it “hurts” to start putting small amounts aside. After a while, you won’t even miss it.

In addition, the IRS has a way to help you get started – it’s called the Saver’s Credit. This is a credit that you receive on your tax return, simply for putting money aside in a savings plan. Pretty sweet deal, if you asked me!

The IRS recently released their Newswire IR-2012-101, which details how the plan works and how you can take advantage of it. The full text of IR-2012-101 is below:

Plan Now to Get Full Benefit of Saver’s Credit; Tax Credit Helps Low- and Moderate-Income Workers Save for Retirement

WASHINGTON – Low- and moderate-income workers can take steps now to save for retirement and earn a special tax credit in 2012 and the years ahead, according to the Internal Revenue Service.

The saver’s credit helps offset part of the first $2,000 workers voluntarily contribute to IRAs and to 401(k) plans and similar workplace retirement programs. Also known as the retirement savings contributions credit, the saver’s credit is available in addition to any other tax savings that apply.

Eligible workers still have time to make qualifying retirement contributions and get the saver’s credit on their 2012 tax return. People have until April 15, 2013 to set up a new individual retirement arrangement or add money to an existing IRA and still get credit for 2012. However, elective deferrals (contributions) must be made by the end of the year to a 401(k) plan or similar workplace program, such as a 403(b) plan for employees of public schools and certain tax-exempt organizations, a governmental 457 plan for state or local government employees, and the Thrift Savings Plan for federal employees. Employees who are unable to set aside money for this year may want to schedule their 2013 contributions soon so their employer can begin withholding them in January.

The saver’s credit can be claimed by:

Married couples filing jointly with incomes up to $57,500 in 2012 or $59,000 in 2013;
Heads of Household with incomes up to $43,125 in 2012 or $44,250 in 2013; and
Married individuals filing separately and singles with incomes up to $28,750 in 2012 or $29,500 in 2013.

Like other tax credits, the saver’s credit can increase a taxpayer’s refund or reduce the tax owed. Though the maximum saver’s credit is $1,000, $2,000 for married couples, the IRS cautioned that it is often much less and, due in part to the impact of other deductions and credits, may, in fact, be zero for some taxpayers.

A taxpayer’s credit amount is based on his or her filing status, adjusted gross income, tax liability and amount contributed to qualifying retirement programs. Form 8880 is used to claim the saver’s credit, and its instructions have details on figuring the credit correctly.

In tax-year 2010, the most recent year for which complete figures are available, saver’s credits totaling just over $1 billion were claimed on more than 6.1 million individual income tax returns. Saver’s credits claimed on these returns averaged $204 for joint filers, $165 for heads of household and $122 for single filers.

The saver’s credit supplements other tax benefits available to people who set money aside for retirement. For example, most workers may deduct their contributions to a traditional IRA. Though Roth IRA contributions are not tax deductible, qualifying withdrawals, usually after retirement, are tax-free. Normally, contributions to 401(k) and similar workplace plans are not taxed until withdrawn.

Other special rules that apply to the saver’s credit include the following:

Eligible taxpayers must be at least 18 years of age.
Anyone claimed as a dependent on someone else’s return cannot take the credit.
A student cannot take the credit. A person enrolled as a full-time student during any part of 5 calendar months during the year is considered a student.

Certain retirement plan distributions reduce the contribution amount used to figure the credit. For 2012, this rule applies to distributions received after 2009 and before the due date, including extensions, of the 2012 return. Form 8880 and its instructions have details on making this computation.

Begun in 2002 as a temporary provision, the saver’s credit was made a permanent part of the tax code in legislation enacted in 2006. To help preserve the value of the credit, income limits are now adjusted annually to keep pace with inflation. More information about the credit is on IRS.gov.

Join in the Movement – Add 1% to Your Savings This Year!

Nov 28th, 2012

by jblankenship.

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Over the past several weeks we’ve been writing articles to encourage all Americans to add at least 1% more to savings in the coming year. More than 20 of my fellow bloggers have submitted articles, and these articles include many great ideas that you can apply in order to increase your savings rate in the coming year.

Since many employees are going through annual benefit elections right about now, it’s a very good time to increase your annual contributions to your retirement savings plans. Big changes are easiest to undertake with incremental steps – starting with adding 1% can have a great impact and get the momentum going!

Listed below are all of the articles that I’ve been notified about so far – 22 23 in all! These folks are very smart, and have shared some great ideas. You owe it to yourself to check it out, and then take action! Add that 1% to your 401(k) or IRA! If you’re a blogger, see the original post for details on how to join the action: Calling All Bloggers!

Listed below are the articles in our movement so far (newest are at the top):

A video tv segment from Laura Scharr: Preparing for Retirement

From Paula Hogan: 6 Ways to Add Another 1% of Income to Retirement Savings in 2013

From Kevin O’Reilly: From TwentySomething to Millionaire

From Tom Batterman: Take the 1% Challenge in 2013!!!

From Dana Anspach: Can You Spare A Penny?

From Steve Doster: The Easy Way to Become a Millionaire

From Nancy Anderson: Save 1% More for Retirement in 2013

From Kathy Stearns: Do the 1% in 2013!

From Ken Weingarten: The 1% Challenge (Should you dare to accept)

From Richard Feight: The 1% Challenge!

From John Hunter: Save What You Can, Increase Savings as You Can Do So