408(k) Plan Definition

What Is a 408(okay) Plan?

The time period 408(okay) account refers to an employer-sponsored retirement financial savings plan. A 408(okay) plan permits staff to place apart pretax {dollars} away for retirement that develop on a tax-deferred foundation, making it a sort of particular person retirement account (IRA). Which means people pay taxes once they make withdrawals after they flip 59½. Plans like these are meant for smaller corporations and self-employed individuals. The 408(okay) is usually known as a simplified worker pension (SEP) plan. In truth, it’s the SEP model of the favored 401(okay) plan.

Key Takeaways

  • A 408(okay) is an employer-sponsored retirement plan akin to a 401(okay).
  • The plan can also be known as a simplified worker pension, which is a sort of particular person retirement account.
  • The 408(okay) plan is obtainable to corporations with 25 or fewer staff and self-employed people who’re topic to the identical contribution limits as employers.
  • Solely employer contributions are allowed into the 408(okay) plan.
  • The IRS limits how a lot employers can contribute to their staff’ 408(okay) plans.

Understanding 408(okay) Plans

Part 408(okay) of the Inner Income Code (IRC) outlines the principles and laws related to SEP and wage discount simplified worker pension (SARSEP) accounts, notably particular person retirement accounts (IRAs) or particular person retirement annuities. That’s the reason SEP plans are also known as 408(okay) plans.

The IRC highlights the necessities wanted with the intention to take part in a 408(okay) plan. Plans can be found to small enterprise homeowners who function with 25 or fewer staff and to self-employed people. Contributors qualify if they’re:

  • Over the age of 21
  • Labored for not less than three of the final 5 years for the employer
  • Have been compensated not less than $450 by the employer

Annual employer contributions can not exceed the lesser of 25% of the worker’s pay or $61,000 for 2022 ($66,000 for 2023). The annual compensation restrict can’t be calculated on incomes exceeding $305,000 for 2022 ($330,000 in 2023). The utmost deduction claimed on a enterprise tax return for contributions is the lesser of the whole contributions into staff’ accounts or 25% of compensation.

Plan holders could make withdrawals from their 408(okay) plans at any time—the identical manner they might from conventional IRAs. However there are specific circumstances that apply. As an example, most people make withdrawals after they flip 59½. Any distributions from these plans earlier than that age incur a ten% early withdrawal penalty. Withdrawals have to be made as required minimal distributions (RMDs) when you attain 72 in case you have been that age on or earlier than Dec. 31, 2022. You could start taking RMDs as of April 1 in case you flip 73 on or after Jan. 1, 2023.

In contrast to conventional retirement plans, SEPs haven’t got the identical start-up or administrative prices.

408(okay) Plans vs. 401(okay) Plans

As famous above, a 408(okay) is one kind of employer-sponsored retirement plan. The 401(okay) plan is the commonest possibility and is obtainable by the overwhelming majority of American companies. The plan permits taxpayers to make pre-tax contributions by way of computerized payroll deductions and employer matches for those who make them.

Plan reform has made a number of modifications to profit staff, together with decrease charges and funding choices. The typical 401(okay) plan now presents almost two dozen funding choices by balancing threat and reward, in accordance with an worker’s preferences. In contrast to an SEP, staff could contribute to a 401(okay) plan. And self-employed people who work for an organization with a 401(okay) can contribute to that plan, too.

Participation in conventional 401(okay) plans continues to develop. These plans held roughly $7.7 trillion in belongings by the top of 2021, which represented about one-fifth of the retirement market in the USA. There have been 600,000 lively plans within the nation with a complete of 60 million staff and retirees on the finish of September 2021.

Listed below are a couple of different details associated to the 401(okay) that taxpayers ought to know:

  • Contribution limits for 401(okay) plans are listed to inflation. The Inner Income Service (IRS) permits staff to save lots of as much as $20,500 for 2022 and $22,500 for 2023. Catch-up contributions of $6,500 per yr (rising to $7,500 in 2023) are additionally allowed for individuals 50 or older.
  • Withdrawals earlier than the age of 59½ typically end in a ten% early withdrawal penalty, except an exemption is utilized. Taxes are imposed on any withdrawals made as contributions are made with pretax earnings.
  • People are required to take RMDs as of the age of 72 in the event that they turned that age between Jan. 1, 2020, and Dec. 31, 2022. The SECURE ACT 2.0 raised that age to 73 for anybody who turned that age on or after Jan. 1, 2023.
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