When it comes to retirement plans, an increasing number of US employers seem to prefer 401(k) plans over other plans. This is largely due to how beneficial these plans are to them, as well as to their employees. 401(k) plans not only provide tax deductions for companies, but also provide an incentive for their employees to stay with them.
These plans also offer small business owners a good opportunity to save for their own future in addition to their employees’. There is a misconception among small-business owners that retirement plans are only for big companies. This is due to the fact that many small business owners believe that they cannot afford such benefits for their employees. However, since 401(k) plans are, for the most part, employee-sponsored, they are beginning to break out of this shell and an increasing number of small business owners are now offering these benefits to their employees.
To fully understand the benefits of these plans, let us first look at what exactly the 401(k) plans are.
401(k) PLANS: WHEN, WHAT AND WHY?
The US Congress, in 1978, passed the Revenue Act, which contained many tax changes to stimulate consumer spending and investment and simplify the tax system. The Act added section 401(k) to the Internal Revenue Code. The name of the plan comes from that section of the Internal Revenue Code.
A 401(k) is a retirement plan that enables eligible employees to save a portion of their salary on a pre-tax/post-tax basis. This amount is often matched by the employer, who might also offer a profit-sharing feature.
In the 401(k) plan, contributions towards retirement savings are deducted from the employee’s salary before taxation. This amount may be proportionately matched by the employer. The amount contributed is determined by either the employee or employer; hence the 401(k) plan is a part of a group of retirement plans called Defined Contribution plans.
TYPES OF 401(k)
There are different types of 401k plans that organisations can offer, such as:
A traditional 401(k), which allows employees to transfer a proportion of their salaries to a retirement account that is offered as a benefit to employees, is considered a viable option for large companies. In this plan, the employee can contribute as much as $18,500 (in 2018) to their account. Employers can make matching contributions based on the amount the employee chooses to contribute.
A safe harbor 401(k) plan ensures that the companies pass their IRS non-discrimination test, by ensuring that all employees, regardless of title, length of service, or compensation, are offered a minimum contribution amount to their 401(k) plans.
A SIMPLE 401(k) allows an employee to contribute only up to $12,500 (2018), excluding the amount contributed by the employer which may be as much as 3% of the employee’s salary. This plan is only offered to small companies, having fewer than 100 employees.
How is 401k different from other plans? The amount that is contributed to the plan is often determined by the employee. Since the money for the plan comes out of the paycheck before the taxes are even calculated, this method is efficient and beneficial.
The employer will often match a portion of the employees’ contributions to provide incentive for them to participate in this plan.
The money is invested in mutual funds, bonds, money market accounts, or any mix of investments determined by the employee. They offer you a list of investment vehicles and guidelines to deliberate on the amount of risk the employee is willing to undertake.
FEATURES OF 401(k)
These are set by the employers to determine who qualifies for the plan. These may be based on age or completing a certain period of service, or simply upon entering the company.
1. Employee deferral contributions
2. Employee match, profit sharing, and non-elective contributions.
1. The limit for employee’s deferral contribution, in the year 2018, is up to $18,500, for traditional and safe harbor 401(k).
2. Employers can contribute as much as $12,500, in the case in the year 2018 for SIMPLE 401(k)
3. Employees over the age of 50 can make additional contributions, if permitted by the plan. This limit is set at $6,000 for Traditional and Safe Harbor 401(k) plans and $3,000 for SIMPLE 401(k) plans, in the years 2015-18.
An employee must be fully vested in the elective deferrals. A plan might require a certain number of years of service before receiving matching contributions or have a vesting schedule.
Employees are permitted to take out loans.
Employees below the age of 59.5 years are allowed to withdraw money but will have to bear an increase of 10% in their taxes.