Do You Understand Your US 401(k) Retirement Plan? Quiz

Answer: Vesting

Money which the employer contributes on your behalf is frequently subject to vesting, which gives you a certain percentage of the funds based on your length of service with the company. The exact vesting schedule varies from one plan to another, but current laws require all employer contributions to be 100% vested after no more than six years of credited service. Money which the employee contributes is always 100% vested.

Answer: False

Many plans now use automatic enrollment to increase participation. However, no individual can be forced to contribute. Rather, an employee who does not specifically elect otherwise will be enrolled by default. That employee always retains the right to contribute a different amount than the default, or not to contribute at all.

Answer: Automobile repairs required to commute to work

The six "safe harbor" hardships are as follows: college tuition; required medical expenses; funeral expenses; purchase of a primary residence; to avoid being evicted or having the mortgage foreclosed on a primary residence; and substantial repairs on a home due to a natural disaster. Crucial car repairs might qualify under the more general hardship definition, but many employers do not use that definition.

Answer: Reaching age 50

The list of distributable events includes retirement, disability, death, severance of employment, termination of the plan, financial hardship, and attainment of age 59-1/2. (Other, very limited circumstances also exist.) If none of these conditions are met, the balance cannot be taken out.

Answer: Normal income tax plus a 10% penalty

Most of the funds in a 401(k) plan have never been taxed to the employee. Thus, taking the money in cash results in normal taxable income. In addition, a 10% early withdrawal penalty applies for most distributions taken before age 59-1/2. Certain exceptions to the penalty do exist, such as payouts to a disabled or deceased participant.

Typically a flat 20% will be withheld for taxes at the time of the payout, but the exact tax will be calculated on the person's income tax return. Depending on the individual's financial situation, this could result in a refund or in more taxes being owed.

Answer: Rollover

A rollover moves money between two investment vehicles, such as 401(k) plans or IRAs, without generating taxable income. It is a good way to keep your retirement funds in one centralized location, without having to worry about the 10% early withdrawal penalty.

Answer: True

If the vested account balance is below $5,000, the IRS allows the employer to forcibly pay out the account if it is not withdrawn promptly. Amounts below $1,000 can be forced out in cash, thus becoming taxable. Amounts between $1,000 and $5,000 can be forced into an IRA as a rollover. Accounts in excess of $5,000 cannot generally be forced out.

Answer: The amount of the loan is limited to the participant's account balance.

Generally speaking, a loan cannot exceed 50% of the participant's vested account balance, rather than the full balance. However, a few plans allow the loan to exceed that amount, up to a total of $10,000, so long as additional collateral is provided.

Other rules include a $50,000 maximum loan amount and the requirement that loans not be more readily available to the top employees than to the rank-and-file employees. Finally, loans must be considered "bona fide." That is, they must have a reasonable term and interest rate, and they must provide for level payment amounts at least quarterly.

Answer: True

Beginning in 2006, some 401(k) plans began adding a Roth feature. While normal 401(k) contributions are made on a pre-tax basis, Roth contributions are made on an after-tax basis. When those funds are eventually withdrawn, the contributions themselves will not be taxed again, but the earnings might be.

In order for the earnings to be tax-free, the participant must have begun making Roth contributions at least five years beforehand, and must have reached age 59-1/2 or have died or become disabled.

Answer: Summary Plan Description (SPD)

The Summary Plan Description contains the plan provisions in language which the average participant should be able to understand. It is required to be provided to every participant in the plan. The Adoption Agreement and Base Plan Document contain basically the same information, but are more high-level, and are not usually provided to employees; however, they must be shown to any participant who requests them.

The Administrative Services Agreement, as its name implies, is a contract between the employer and a separate company that has been hired to administer the plan.