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401k Frequently Asked Questions

401k FAQ's
What is a 401(k) Plan
General Information
Plan Documents
Plan Administration

Other FAQ's
Qualified Plan Distributions
IRA Accounts
Defined Benefit plans
401(k) plans
403(b) plans
457 plans
529 College Savings Plans

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 Earnings withdrawn before an investor reaches age 59 1/2 may be subject to a 10% IRS penalty.

Your 401(k) plan may offer investment options through:
a group fixed and variable deferred annuity, or
a selection of mutual funds, or
a selection of bank products, or
a combination or all three.

How are contributions to my 401(k) plan invested?

Money you contribute is invested at your direction in one or more of a variety of investment options managed by some of the most reputable and recognized names in the industry.

Many plans offer both fixed and variable investment options. The fixed options through bank and insurance company products guarantee principal and interest. The variable options through insurance company products, bank products or mutual funds provide "variable" returns, which are not guaranteed. The rate of return you receive on a variable option may increase or decrease depending upon the investment performance of your account.

The selection of investment options available to you is determined by your employer and may change from time to time.

May I transfer between the different investment options?

Generally, you may transfer, at no charge:
To or from any variable option on any business day
Into a guaranteed interest option on any day
Out of fixed investment options as allowed by each option Certain transfer restrictions and fees may apply depending on the investment options available under your plan.

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":
  • Total and permanent disability as defined by IRS regulations
  • Retirement
  • Termination of service as defined by IRS regulations
  • Financial hardship(1) as defined by IRS regulations
  • Age 59 1/2 as defined by IRS regulations
  • Loans (1) as defined by IRS regulations

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:

  • reach age 70 1/2, or
  • separate from service with the employer sponsoring your plan.

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?

If you leave your current employer, you have some choices to make about your plan. Generally, you may:
Leave your money invested in the plan until your required distribution date.
Transfer your vested assets into your new employer's 401(k), if allowed by each plan.
Withdraw your money, subject to withdrawal charges and/or fees., distributions are taxable, penalties may apply.
Roll your vested account balance into an IRA subject to withdrawal charges and/or fees.

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

The death benefit available for money you have invested in options under a group fixed and variable deferred annuity depends on your age at death and whether or not your annuity payments have started. In general, at your death, the money invested in your plan will be paid to your designated beneficiary according to the death benefit provisions in the annuity contract.

Mutual funds

The account value in mutual funds as of the date of death will be paid to your designated beneficiary.

All death benefits will be paid in accordance with the payout method you have selected. If you die before selecting a payout method, your beneficiary will be allowed to select one for the distribution of your remaining account value.
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.



What 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. Contact us at Advanced Corporate Planning for more information on 401(k) prototype plan documents.


or call us at (360) 750-9626, or fax: (360) 635-4424.

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.


Who 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:

  1. Provide summary plan descriptions, summary annual reports, benefits statements and other required information to plan participants;
  2. File reports with IRS, Department of Labor (DOL) and if applicable, the PBGC (Pension Benefit Guaranty Corp.);
  3. Maintain records relating to the operation of the plan with sufficiently detailed information to verify the accuracy of the various reports.

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.



What 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.

  • Ratio percentage test - the percentage of Non-Highly Compensated (NHC) active employees who benefit under a plan equals at least 70% of the percentage of the active Highly Compensated Employees who benefit under a plan. (example: a company's plan covers 60% of the company's NHC employees and 80% of the HCE employees. The plan's ratio percentage is 75% (60% divided by 80%), and thus satisfies the ratio percentage test.)
  • Average benefit test - the average benefit percentage for NHC group must be at least 70% of the average benefit percentage of the HCE group. The term "average benefit percentage" applies to the employer provided contributions expressed as a percentage of each employee's compensation.



What 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 retire.


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Lynn R. Siewert, AIMC, CRPS
Pension Consultant |   Branch Manager
CA Insurance License #00B00579
2005 E. Evergreen Blvd
Vancouver, WA 98661
Ph: 360-750-9626

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