Can We Withdraw Owed Money From Employees’ 401(k) Accounts?

Editor’s note: This Dear Workforce question features two responses from experts.

Dear We Want Our Money:

The short answer is "absolutely not." A 401(K) account belongs to an employee; it is his or her property. An employer cannot dip into an employee's account and withdraw funds, even if the employee owes money to the employer. An employer who withdraws money from an employee's 401(K) account is committing a theft, and is probably also violating several federal securities, banking, or benefits laws.

It's just as illegal as hiring someone to mug the employee on his or her way home from work for the money. If your goal is to incent the employee to remain employed for a period of time after completing the coursework so that you get some bang for your educational buck, there are better way to accomplish this goal. For example, why not consider paying the tuition as a reimbursement to the employee at the six-month point if the employee remains employed. That way, the employee must stay for your chosen amount of time to collect the reimbursement.

SOURCE: Jon Hyman, Meyers Roman Friedberg & Lewis, Cleveland, Ohio, Sept. 18, 2015.

The short answer is “no.” One of the basic things to understand about a 401(k) plan, or any plan intended to be “tax-qualified,” is that the plan and the employer are two different entities under the law. Generally, once money has been contributed to a plan, it “belongs” to the plan, and the employer cannot take it back or require the employee to give it back.

For a plan such as a 401(k) plan to be tax qualified, it must satisfy a number of rules including the anti-alienation rule of IRC 401(a)(13). Under that provision, with elaboration from the regulations, benefits provided under the plan cannot be “anticipated, assigned, alienated or subject to attachment, garnishment, levy, execution or other legal or equitable process.” There are specific exceptions for, among other things, federal tax levies and other federal tax-collection actions, as well as qualified domestic relations orders and certain judgments for crimes or fiduciary breaches against the plan.

One of the items specifically prohibited under the anti-alienation rules is any arrangement providing for the payment to the employer of plan benefits that would otherwise be because of the employee under the plan. Thus, any attempt by an employer to take amounts from an employee’s account to repay the employer for tuition would be a violation of IRC Section 401(a)(13), which would disqualify the plan. Note that employees are permitted to make certain voluntary assignments of plan benefits, but such assignments must be revocable by the employee at any time.

As a result, the best way for employers to ensure that such tuition amounts are returned to the employer is to make sure the program or contract provisions under which the tuition payments are disbursed provide adequate protection for repayment if the employee leaves within a short time after such payments were made. An automatic deduction from an employee’s 401(k) plan account for repayment purposes is not permitted.

Please note that the anti-alienation rules of IRC Section 401(a)(13) do not apply to public sector (governmental) plans. However, there may be similar employee protection under the laws of the applicable state.

SOURCE: John K. Graham, Sibson Consulting, New York City, Sept. 29, 2015.