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Your Money's Journey Into Your 401k

The movie "Fantastic Voyage" was on TV the other day, and watching the miniature submarine travel through Jan Benes' body got me thinking about what happens inside a 401k plan.


Many participants may wonder where exactly their money goes between the time it's deducted from their paychecks and the time it appears in their 401k account. Sometimes this process can take a while.

We'll give you a guided tour of what happens to your money. You won't have to be shrunk to take this tour -- you can do it from the safety of your chair.

The Players

Before starting, you should know the cast of characters you'll be meeting: you (as the 401k participant), your employer (as the plan sponsor), the recordkeeper, the trustee and the investment manager.

Your employer sets up the plan, chooses the investments available to you, deducts your contributions from your pay, and sends the contributions to the recordkeeper. While your employer typically has little responsibility for the day-to-day managing of your plan, it defines the rules of how the plan operates (within the broad guidelines allowed by the IRS and Department of Labor).

The recordkeeper is the firm or individual that:

  • tracks your contribution rates, investment selections and balance
  • tracks the amount of employer matching contributions due to you (if you receive a match)
  • provides account statements
  • maintains information about any outstanding 401k loan(s) you might have, such as balance due, monthly payment and interest due.

Recordkeeping services are commonly provided by accountants, payroll services providers, brokerage firms and mutual fund companies.

A 401k plan needs a recordkeeper because 401k savings are commonly aggregated into what is known as an omnibus account. In this account, all of your investments are lumped together with those of the other participants in your plan.

The plan trustee actually holds title to the assets, but for your benefit. The recordkeeper keeps track of who has what, and where, on behalf of the trustee, who oversees the trust account.

"Legally, it is the trust that holds the money. It has to be the trust's name on the account," said Paul Davidson, director of human resources services with Paychex Inc., a 401k recordkeeper and payroll company.

By law, all 401k savings must be held in a trust account, separate from the assets of your employer, so that you and your employer, and your respective creditors, can't get your money prematurely. The rules stipulating the use of a trust are contained in the Employee Retirement Income Security Act (ERISA). It covers employee benefits such as pensions, healthcare and 401k plans.

Suppose you or your employer declares bankruptcy. Federal law says creditors aren't allowed to seize your 401k savings, and the trustee is who protects your money. Trustee services are provided by businesses such as brokerage firms, mutual fund companies, banks and trust companies. An individual may also serve as a trustee.

The trustee also ensures that your contributions and withdrawals are made according to your plan's rules. The trustee also invests your money according to your wishes. The trustee is like a personal bodyguard and police officer for your 401k savings. But, the one thing your trustee can't do is prevent you from making poor investment decisions. That's your responsibility.

The investment manager is the individual or firm that offers the investments available to you. These typically are brokerage firms or mutual fund firms.

Depending on the plan, the recordkeeping, trustee and investment manager roles may be filled by the same or different companies or individuals.

Journey Starts Here

Your money's journey starts when you sign up to participate in your plan. When you fill out your 401k-enrollment form, you specify how much money you want to contribute to the plan and how it should be invested.

This form gives your employer permission to take your contribution from your pay before the IRS taxes it, and to invest the money on your behalf. The Department of Labor requires your employer to send your contributions to the 401k plan as soon as possible, and in any case no later than 15 working days after the end of the month in which you make them. Many employers send employee contributions to the plan within a few days of payroll.

"The Department of Labor doesn't want the employer holding the money at all," said Jeffrey Baddish, vice president and CPA with BaddishShapiro Financial Planning Group, of Mineola, N.Y. "They will audit and check when (the employer) is making contributions. There is no reason the employer should hold the money."

Employer contributions are subject to a different set of contribution deadlines. The employer must make its contribution no later than the day it files its corporate income tax return, including extensions. However, many employers make matching contributions at the same time employee contributions are sent to the plan's trust account.

A copy of your enrollment and investment selection form is sent to the recordkeeper who helps manage the 401k plan. Every time your employer pays you, it defers the amount you designated on your form. Your employer collects this money from all participants and sends it to the trustee. At the same time, your employer notifies the recordkeeper of how much each participant contributed and how the money should be invested. If you have a 401k loan, your payment is deducted from your after-tax income, and your loan is recalculated.

Before the money is actually deposited in the trust, the employer and recordkeeper make sure that these records are accurate. "If the plan isn't correct, (the employer) could be in violation of the law," said David Wray, president of the Plan Sponsor Council of America.

Consequently, it could take a day or two to work out administrative details before your money is actually deposited in your plan's trust account, Wray added.

When the money reaches the trust, the trustee invests it with the investment manager, according to the participants' instructions.

Often the money is invested that day or the next, depending on when it arrives.

You may be wondering why it takes so long for your money to be posted to your account. It's a good question.

Two methods of 401k plan accounting are commonly used: daily valuation and balance forward.

With daily valuation, your account balance and investments are updated every day. If your plan uses daily valuation, your contributions should be invested within two to three days after payday and your account balance should be updated within a week, plan experts say.

With balance forward, most commonly used by small companies with older plans, your money is immediately deposited in the trust account, but it may take a month or more before it's invested.

Taking Money Out

The process of withdrawing money from a 401k plan isn't too much different from the process of putting it in. To withdraw money (assuming you are eligible under the rules of your plan), you file a withdrawal request form, specifying whether you want to take custody of the money or roll it over to another account or plan, such as an IRA.

Your employer sends the form to the recordkeeper, which sends it to the trustee, who in turn checks to make sure the withdrawal form is valid and complies with the plan's rules. If you apply for a plan loan, you fill out a loan application that takes the same path as a withdrawal form.

The trustee notifies the investment manager to sell your funds. The proceeds of the sale are returned to the trustee, who in turn sends the money to your employer. The employer then sends or hands the money to you. If you are cashing out from the plan, your employer will be required by the IRS to withhold at least 20 percent of your withdrawal for income tax. But, if you designate that the money is to be rolled over to another tax-deferred account, the check will be made payable to that account and there are no tax consequences.

At the end of the year, regardless of where the money goes, your employer will file an IRS Form 1099-R reporting your distribution.

This is for educational purposes only. 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.

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