How to Protect your Pension Plan Assets Against Taxes and Risk

The same is true with bonds except the drivers are not only the economy but also interest rates and the creditworthiness of the issuing company. During 2008:1Q the markets were mostly down and so were your 401(k) assets. Not to worry, you say, because this is your retirement money and there is lots of time to recover from market downturns. True, unless you're in the red zone right before retirement (say age 57 or more). Did you know that in the last major market meltdown (2000-02) the S&P index, a major barometer of the stock market, dropped 50% of it value. Those in retirement's "red zone" were victimized with huge losses and the results were: postpone retirement or scale down the planned retirement. What can you do to protect your 401(k) assets if you're scared stiff that a major market downturn will ruin your retirement?

The Employee Retirement Income Security Act of 1974 ("ERISA") and the IRS allow you to transfer some or all of your money out of your 401(k) without stopping work, without retiring and without ending your participation in your employer's 401(k) plan. However, your employer has the right to prevent you from transferring, or load with qualifications and restrictions, what ERISA and the IRS permit. To allow such transfers your employer must add an amendment to the plan which allows in-service, non-hardship withdrawals ("INNHW"). This provision can be straightforward with few restrictions or it can be very restrictive -- your employer gets to decide. Most large companies have added the amendment because recent court cases, and the bankruptcy of Enron which also resulted in massive losses of their employees 401(k) assets, have opened a Pandora's box about the fiduciary responsibility of employers to do all they can to help employees protect their retirement money in plans they sponsor. Below is what the INNHW amendment, in it most liberal form, will allow and still permit the employee to still work and continue contributing to the 401(k) plan.

An employer profit sharing and matching contributions, plus any money the employee transferred to the plan from another qualified pension plan, and the earnings on such money, can be transferred into a self-directed IRA and neither ERISA or the IRS impose an age restriction. However, the employer has the right to stipulate that only "vested" amount may be transferred and they can also set a minimum age that an employee must reach before transfers can occur. They can also add other restrictions like: (a) a minimum number of years employed; (b) limit the percentage that can be transferred; (c) cease or reduce matching contribution for a specified period following a transfer; (d) limit or prevent participation in the plan for a given period of time. In fact, the employer can add almost any restriction they want provided the uniformly apply it across all employees. The INNHW amendment applies to all employees, including owners, partners and senior management.

ERISA and the IRS allow the employee contributions to be transferred without penalty and without taxes being paid once the employee reach age 591/2 years of age. Again, the employer can impose limitations and restrictions on such transfers in the ISNHW amendment. Why would anyone want to transfer their retirement money from their 401(k) to a self-directed IRA?

The major benefit of in-service, non-hardship transfers by plan participants is the opportunity to protect their retirement money from the vagaries of the market, reduce unsuitable risk, take advantage of anticipated changes in tax rates, and convert moneys to a Roth IRA during the income suspension window in 2010. If a participant is currently near retirement, they may have insufficient time to recover from market downturns or bolster their savings rate to make up losses. The resulting stress could easily affect their job efficiency.

It is a foregone conclusion that the marginal tax brackets and capital gains taxes will increase when the deficit reduction tax breaks of the Bush Administration expire in 2010 and 2011. By re-positioning qualified retirement money now, it should be possible to manage favorably the tax liabilities associated with retirement money in employer plans. The higher-income participants have the added advantage of converting all or some of their qualified retirement assets to a Roth IRA in 2010. The tax relief is likely to be a short-lived window of opportunity. By transferring moneys from employer plans to self-directed IRAs, participants have virtually unlimited investment options: domestic and foreign stocks, bonds and general securities, bank CDs and other insured accounts, annuities, real estate, commodities, business interests, limited partnerships and more. Once the retirement money is moved outside the plan, professional money managers can be used to meet specific and individual investment objectives. The investment options inside most plans are simply not sufficient to address the variability of assets from lowest paid employee to business owner. Plus, the typical plan participant receives very little advice on which plan options to select and how much to allocate to each. Money in an IRA at the participant's death can be added directly to the spouse's IRA or "stretched" by a beneficiary over their remaining lifetime. Unless the employer's plan allows for spousal and beneficiary transfers at death, the lump-sum pay out could result in substantial taxes for the beneficiary. The "stretch" option with an IRA can be a great estate planning tool.

The management and administrative fees associated with employer plans can be onerous. By selecting no-load, indexed or other low load options once moneys are moved outside the plan, these fees can be substantially reduced. Since the typical fees charged employer plans approach two percent of total assets, the reduction to zero or a few basis points can make a significant difference in performance over a long period of time. If the employer is paying the fees, fewer assets in the plan means cost savings. There is a growing consensus that Social Security benefits should be postponed as long as possible to maximize lifetime benefits. Accordingly, early retirement may be financed more with plan assets and IRAs, and these should be positioned in place now to avoid the expected higher income taxes starting in 2011 and beyond. This is especially true of moneys destined for Roth IRAs.

Making plan assets available for transfer to self-directed IRAs would be a decided morale booster for those in the red zone near retirement and also a stress reducer. Both of these benefits could translate into increased employee productivity. If a participant retires early, they can take distribution from a 401(k) plan at age 55 whereas IRAs permit penalty-free withdrawals only after age 59½. Accordingly, those planning to retire prior to age 59 1/2 should carefully consider whether or not to remove employer profit sharing/matching funds and other eligible withdrawals pursuant to the in-service, non-hardship amendment. Of course, by using an IRC Sec. 72(t) election, IRA money can be taken at any age provided substantially equal payments are taken for the longer of five years or until age 59½ is reached. Some employer plans permit borrowing for a first home, educational expense, medical emergencies, and more; however, IRAs do not offer broad borrowing privileges. Thus, if money from a qualified plan will be needed prior to age 59½ and the employer's plan allows borrowing, converting to an IRA should be carefully evaluated.

Special care should be exercised if a participant owns the employer's stock inside the plan. There can be decided income tax advantages by moving the stock to a taxable account, paying ordinary income taxes on the original basis, and holding for the required time to qualify for capital gains taxes on the appreciation above the basis. It is strongly recommended that the advice of a financial advisor be sought if there is net unrealized appreciation of employer's stock inside a pension plan.

Okay, how do you go about finding out if your employer's 401(k) plan contains an ISNHW amendment? You can either asked the plan administrator (the Human Resources department can give you the name and/or the answer) or you can review the Summary Plan Document that you received when you started participating in the 401(k). Again, the Human Resources department can provide you copies of the Plan Summary. What if your plan does not have an ISNHW amendment?

Adding the amendment is a simple and costless process. Your employer need to instruct the plan administrator to add the amendment. Of course, the employer will have the option of adding restrictions and limitations...so you'll want to lobby them to do the right thing. Be aware, and also warn your employer, that the plan administrator is paid fees based on the number of participates in the plan and the amount of money in the plan. So, expect them to object to the ISNHW amendment because as money is transferred their fees will decline. By the way, if you'd like to see how much the fees are on your plan -- and also the actuarial rate of return -- you can view the DOL Form 5500 which is filed annually by your employer by going to freeERISA. Just search by zip code and find your employer. This can be a real eye-opener.

Probably the best way to get your employer's attention is to refer a financial advisor that specializes in ISNHW amendments to your employer. If you don't know such an advisor, just visit The Retirement Pros and "ask the pros" to help you find one. We'll be glad to make a recommendation. And while you're at it, take a look at my most recent publication titled "Protecting Pension Plan Assets Against Taxes and Risk" by going to TheRetirementPros.com and clicking "Retirement Planning".