Ted's Table

TB: The new loan may not exceed $50,000 less the highest outstanding balance during the one-year period before the date the new loan is made. Since you didn't say, let's assume that the highest outstanding balance was $27,000, during this one-year period, the additional amount you may borrow may not exceed $23,000. ($27,000+$23,000=$50,000) Sticking with this example, since your employer permits only one loan at a time, the maximum amount you could borrow, after repaying the existing loan, would be the sum of the balance from the existing loan ($19,200) and $23,000 or a total of $42,200. These numbers must be adjusted using the actual amounts on the date the new loan is made.

TB: You're correct that loans must be paid from after-tax income regardless of whether they're done inside or outside a 401(k). Repaying a loan usually is painful regardless of the source because we must earn the money, pay taxes, and then repay the principle plus interest.

One point I'd like to make is you won't have to pay tax on your after-tax contributions when you take withdrawals. You will, however, have to pay tax on the interest those contributions earned.

Historically I've referred to the double-tax issue only with respect to the interest that you pay yourself with a 401(k) loan. The fact that the interest is double-taxed should be considered in addition to the relative investment results.

TB: Most tax advisors recommend getting whatever tax break you can now. The biggest issue is to continue saving at your present level. If you're under age 50, you should probably continue to build your retirement nest egg by contributing to the 401(k). If you are over 50 and have the discipline to save on your own outside the plan, you may want to reduce your savings rate within the 401(k) rather than stopping altogether.

TB: Many bills are introduced in Congress each year. A significant number of them are introduced with little or no expectation that they will be enacted. The specific change you inquired about isn't likely to happen any time soon.

TB: If the company says "sorry for the goof but there isn't anything we can do" your friend's options are somewhat limited. The first option would be to inform the person who oversees the plan at the company that he will contact the Department of Labor if the company doesn't make up the lost contributions. The next option would be to obtain an attorney to legally pursue this matter. Before your friend does either of these, he should consider how the employer would react. Is your friend likely to be viewed as a "troublemaker" if he pursues this further? If so, is it worth the risk?

Correcting what has happened will be somewhat difficult, and perhaps impossible, since the money wasn't deducted from his pay during 1999. The employer could permit your friend to make up the contributions this year. Additionally, it could match these additional contributions to the extent they would have been matched last year, even though this will probably exceed the employer-matching-contribution limits for this year. This special matching arrangement probably will have to be done outside the terms of the plan document. The IRS generally permits mistakes to be corrected particularly when the corrective action doesn't involve employees who are part of the highly compensated group. The employer could also contribute the lost investment income as a special additional contribution.

TB: The only security held within a 401(k) plan that may ultimately be taxed at the capital gain rate is employer stock. If the shares you purchased are employer stock, when you leave the company and receive the stock as a lump sum distribution from the plan, you must pay tax on the value of the stock based upon the value at the time the stock was acquired. You won't pay tax on the gain until you sell the stock and it will be treated as a capital gain.

This special tax break applies only to employer stock. If you purchased the stock of some other company within the 401(k) plan, the amount ultimately distributed to you will all be taxed as ordinary income. That is why many financial planners recommend to those who are investing significant amounts inside and outside a tax-sheltered plan such as 401(k) to place their income-generating investments inside the tax-sheltered plan and their growth investments outside the plan.

Ted Benna, creator of the first 401(k) retirement savings plan, will answer your most intriguing questions every week. With over 30 years of experience as an employee benefits consultant, Ted is a nationally recognized expert on benefits issues. He has authored two books, Helping Employees Achieve Retirement Income Security and Escaping the Coming Retirement Crisis, and is President of the 401(k) Association. Ted is a frequent speaker at meetings of 401(k) plan sponsors and participants. His articles and comments have appeared in numerous publications, including The New York Times and The Wall Street Journal.

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

Ted's Table

TB: The new loan may not exceed $50,000 less the highest outstanding balance during the one-year period before the date the new loan is made. Since you didn't say, let's assume that the highest outstanding balance was $27,000, during this one-year period, the additional amount you may borrow may not exceed $23,000. ($27,000+$23,000=$50,000) Sticking with this example, since your employer permits only one loan at a time, the maximum amount you could borrow, after repaying the existing loan, would be the sum of the balance from the existing loan ($19,200) and $23,000 or a total of $42,200. These numbers must be adjusted using the actual amounts on the date the new loan is made.

TB: You're correct that loans must be paid from after-tax income regardless of whether they're done inside or outside a 401(k). Repaying a loan usually is painful regardless of the source because we must earn the money, pay taxes, and then repay the principle plus interest.

One point I'd like to make is you won't have to pay tax on your after-tax contributions when you take withdrawals. You will, however, have to pay tax on the interest those contributions earned.

Historically I've referred to the double-tax issue only with respect to the interest that you pay yourself with a 401(k) loan. The fact that the interest is double-taxed should be considered in addition to the relative investment results.

TB: Most tax advisors recommend getting whatever tax break you can now. The biggest issue is to continue saving at your present level. If you're under age 50, you should probably continue to build your retirement nest egg by contributing to the 401(k). If you are over 50 and have the discipline to save on your own outside the plan, you may want to reduce your savings rate within the 401(k) rather than stopping altogether.

TB: Many bills are introduced in Congress each year. A significant number of them are introduced with little or no expectation that they will be enacted. The specific change you inquired about isn't likely to happen any time soon.

TB: If the company says "sorry for the goof but there isn't anything we can do" your friend's options are somewhat limited. The first option would be to inform the person who oversees the plan at the company that he will contact the Department of Labor if the company doesn't make up the lost contributions. The next option would be to obtain an attorney to legally pursue this matter. Before your friend does either of these, he should consider how the employer would react. Is your friend likely to be viewed as a "troublemaker" if he pursues this further? If so, is it worth the risk?

Correcting what has happened will be somewhat difficult, and perhaps impossible, since the money wasn't deducted from his pay during 1999. The employer could permit your friend to make up the contributions this year. Additionally, it could match these additional contributions to the extent they would have been matched last year, even though this will probably exceed the employer-matching-contribution limits for this year. This special matching arrangement probably will have to be done outside the terms of the plan document. The IRS generally permits mistakes to be corrected particularly when the corrective action doesn't involve employees who are part of the highly compensated group. The employer could also contribute the lost investment income as a special additional contribution.

TB: The only security held within a 401(k) plan that may ultimately be taxed at the capital gain rate is employer stock. If the shares you purchased are employer stock, when you leave the company and receive the stock as a lump sum distribution from the plan, you must pay tax on the value of the stock based upon the value at the time the stock was acquired. You won't pay tax on the gain until you sell the stock and it will be treated as a capital gain.

This special tax break applies only to employer stock. If you purchased the stock of some other company within the 401(k) plan, the amount ultimately distributed to you will all be taxed as ordinary income. That is why many financial planners recommend to those who are investing significant amounts inside and outside a tax-sheltered plan such as 401(k) to place their income-generating investments inside the tax-sheltered plan and their growth investments outside the plan.

Ted Benna, creator of the first 401(k) retirement savings plan, will answer your most intriguing questions every week. With over 30 years of experience as an employee benefits consultant, Ted is a nationally recognized expert on benefits issues. He has authored two books, Helping Employees Achieve Retirement Income Security and Escaping the Coming Retirement Crisis, and is President of the 401(k) Association. Ted is a frequent speaker at meetings of 401(k) plan sponsors and participants. His articles and comments have appeared in numerous publications, including The New York Times and The Wall Street Journal.

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.