Ted's Table

Technical Terms Early withdrawal penalty Employee Retirement Income Security Act (ERISA)

Last time, I asked for help from anyone who is familiar with any special provision to exempt tribal plans from needing to file an IRS Form 5500 (the 401(k) annual report) and we got it from a group of benefits industry attorneys and other experts at Tagdata.com. Below is an excerpt from the message they sent. I would like to thank them for their help. —Ted

"Indian tribal governments, subdivisions of Indian tribal governments, agencies or instrumentalities of Indian tribal governments, or subdivisions thereof, may offer 401(k) plans to their employees (Code Sec. 401(k)(4)(B)(iii)). The specific authorization for 401(k) plans maintained by Indian tribal governments is effective for plan years beginning in 1997. They do not have to file 5500 forms.

"Plans sponsored by Indian tribal governments are considered governmental plans. Governmental plans are exempt from ERISA's participation, minimum coverage, vesting, and funding standards (ERISA Sec. 4(b)(1))."

TB: I'm not familiar with the requirements to qualify for Medi-Cal but in many instances retirement plan assets are not considered when determining eligibility for various forms of private and public assistance. Make sure you have the right answer for Medi-Cal purposes. You should consider getting help from an attorney who is familiar with Medi-Cal. If your retirement funds are a factor impacting Medi-Cal eligibility, it's possible that transferring your 401(k) to someone else immediately prior to applying may void your eligibility. If any of our readers have any input that may help this person, I would appreciate it.

If you try to transfer the money, you will have to pay income tax. You will also have to pay the 10 percent early distribution penalty if you were under age 55 when you left your former employer. If you were older than age 55, you may be able to take your money penalty-free under the early retirement rules. You will still have to pay income taxes on your withdrawal.

To answer the question of how much you would owe, your 401(k) withdrawals would be added on top of any salary or other income you received and you would be taxed at your normal income tax rate. The 10 percent penalty would be assessed on the amount you withdrew from the account.

You may give a maximum of $10,000 to anyone without any additional tax under the gift tax rules. Typically, you make this gift to a child, grandchild or other relative. After paying the taxes when you withdraw the money, I expect you will probably have to make gifts to at least three people to exhaust the entire amount.

These individuals can give the money back to you in the future without tax; however, you will have to trust them. Unfortunately this type of planning commonly goes awry because the other party doesn't stick to his or her end of the deal.

TB: The Employee Retirement Income Security Act (ERISA) prohibits you from assigning your 401(k) benefits. You may violate this restriction and give the company that loans you the money an assignment but it isn't legally enforceable. Your employer would be legally required to reject the lender's claim in the event of a default. The only way your 401(k) money could be used to pay the loan is if you willingly took the money out of the plan. The plan probably permits you to withdraw the after-tax money at any time. The pretax money may be withdrawn while you are still employed only after age 59½ or for one of the financial hardships approved by the IRS. Repaying a defaulted business loan wouldn't qualify.

Related Reading Don't Tap Your 401(k) to Pay Off Debt Emergency Access to Your 401(k): Hardship Withdrawals Follow the 401(k) Money Trail: Where It Begins, Where It Ends

Bottom line, the potential lender may consider your 401(k) money when deciding to make this loan to you, but it also has to consider the fact that this money will be used to repay the loan only if you willingly take it out of the plan rather than defaulting. That is a business decision the company will have to make. If I were that company, I would wonder why you aren't taking out at least the after-tax money to invest in this venture rather than borrowing from a third party.

From a more personal perspective, I question the soundness of this venture if the company willing to back you is so concerned about financial security if you fail that they are asking you to violate the law and assign an asset that cannot be assigned.

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

Technical Terms Early withdrawal penalty Employee Retirement Income Security Act (ERISA)

Last time, I asked for help from anyone who is familiar with any special provision to exempt tribal plans from needing to file an IRS Form 5500 (the 401(k) annual report) and we got it from a group of benefits industry attorneys and other experts at Tagdata.com. Below is an excerpt from the message they sent. I would like to thank them for their help. —Ted

"Indian tribal governments, subdivisions of Indian tribal governments, agencies or instrumentalities of Indian tribal governments, or subdivisions thereof, may offer 401(k) plans to their employees (Code Sec. 401(k)(4)(B)(iii)). The specific authorization for 401(k) plans maintained by Indian tribal governments is effective for plan years beginning in 1997. They do not have to file 5500 forms.

"Plans sponsored by Indian tribal governments are considered governmental plans. Governmental plans are exempt from ERISA's participation, minimum coverage, vesting, and funding standards (ERISA Sec. 4(b)(1))."

TB: I'm not familiar with the requirements to qualify for Medi-Cal but in many instances retirement plan assets are not considered when determining eligibility for various forms of private and public assistance. Make sure you have the right answer for Medi-Cal purposes. You should consider getting help from an attorney who is familiar with Medi-Cal. If your retirement funds are a factor impacting Medi-Cal eligibility, it's possible that transferring your 401(k) to someone else immediately prior to applying may void your eligibility. If any of our readers have any input that may help this person, I would appreciate it.

If you try to transfer the money, you will have to pay income tax. You will also have to pay the 10 percent early distribution penalty if you were under age 55 when you left your former employer. If you were older than age 55, you may be able to take your money penalty-free under the early retirement rules. You will still have to pay income taxes on your withdrawal.

To answer the question of how much you would owe, your 401(k) withdrawals would be added on top of any salary or other income you received and you would be taxed at your normal income tax rate. The 10 percent penalty would be assessed on the amount you withdrew from the account.

You may give a maximum of $10,000 to anyone without any additional tax under the gift tax rules. Typically, you make this gift to a child, grandchild or other relative. After paying the taxes when you withdraw the money, I expect you will probably have to make gifts to at least three people to exhaust the entire amount.

These individuals can give the money back to you in the future without tax; however, you will have to trust them. Unfortunately this type of planning commonly goes awry because the other party doesn't stick to his or her end of the deal.

TB: The Employee Retirement Income Security Act (ERISA) prohibits you from assigning your 401(k) benefits. You may violate this restriction and give the company that loans you the money an assignment but it isn't legally enforceable. Your employer would be legally required to reject the lender's claim in the event of a default. The only way your 401(k) money could be used to pay the loan is if you willingly took the money out of the plan. The plan probably permits you to withdraw the after-tax money at any time. The pretax money may be withdrawn while you are still employed only after age 59½ or for one of the financial hardships approved by the IRS. Repaying a defaulted business loan wouldn't qualify.

Related Reading Don't Tap Your 401(k) to Pay Off Debt Emergency Access to Your 401(k): Hardship Withdrawals Follow the 401(k) Money Trail: Where It Begins, Where It Ends

Bottom line, the potential lender may consider your 401(k) money when deciding to make this loan to you, but it also has to consider the fact that this money will be used to repay the loan only if you willingly take it out of the plan rather than defaulting. That is a business decision the company will have to make. If I were that company, I would wonder why you aren't taking out at least the after-tax money to invest in this venture rather than borrowing from a third party.

From a more personal perspective, I question the soundness of this venture if the company willing to back you is so concerned about financial security if you fail that they are asking you to violate the law and assign an asset that cannot be assigned.

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.