- 401(k) Plans
A 401(k) plan is a retirement plan under which an employee can elect to have their employer contribute a portion of their wages to a retirement account. The wages contributed are known as “elective deferrals” and are not subject to federal income tax at the time of deferral.
The main tax advantages of sponsoring a 401(k) plan are:
- Employer contributions are deductible on the employer’s federal income tax return to the extent that the contributions do not exceed certain limitations.
- 401(k) contributions and investment gains are tax deferred until distribution in retirement.
The maximum employee contribution that can be made to the plan in 2015 and 2016 is $18,000. For those employees age 50 years of age or older, a $6,000 additional contribution can be made. In a 401(k) plan the employer can make matching contributions for employees.Contributions must be made no later than the extended due date of the employer’s tax return.
There are several types of 401(k) plans available to employers including traditional 401(k) plans, safe harbor 401(k) plans, and SIMPLE 401(k) plans. Below is a brief description of each type.
a. Traditional 401(k) Plan
A traditional 401(k) plan allows eligible employees to make pre-tax contributions through payroll. In a traditional 401(k) plan, employers have the choice to make contributions on behalf of all participants, make matching contributions based on employees’ contributions, or both.
b. Safe Harbor 401(k) Plan
A safe harbor 401(k) plan is similar to a traditional 401(k) plan, however, employer contributions must be fully vested when made. Both the safe harbor and traditional 401(k) plans are for employers of any size and can be combined with other retirement plans.
c. SIMPLE 401(k) Plan
The SIMPLE 401(k) plan was formed so that small businesses could have an efficient, cost-effective way to offer retirement benefits to their employees. This type of 401(k) plan is available to employers with 100 or fewer employees who received at least $5,000 in compensation from the employer for the previous calendar year. Employees who are eligible to participate may not receive any contributions or benefit accruals under any alternative plans of the employer.
Simplified Employee Pension (SEP) plans are easy to set up and maintain, as they do not have the start-up and operating costs of a conventional retirement plan. Any employer with one or more employees is eligible to provide them, and it is commonly seen with sole proprietorships for its flexibility and simplicity.
In 2015 and 2016, the maximum that one can contribute to a SEP is the lesser of $53,000 or 25% of the employee’s salary. For those employees over 50 years of age, a $6,000 additional contribution can be made. Contributions for each year must be made no later than the extended due date of the employer’s tax return. Annual contributions can be flexible, making this a good plan if cash flow is an issue from one year to the next. If the employer plans to contribute anything to an employee’s SEP, they must contribute equally for all employees that are eligible.
- Simple IRA
SIMPLE IRA plans can offer a substantial source of income for retirement by permitting both employers and employees to set aside money in retirement accounts. An advantage of a SIMPLE IRA is that it does not have the start-up and operating costs of a conventional retirement plan. It is available to any small business with 100 or fewer employees. Under a SIMPLE IRA, an employer is required to annually contribute either a matching contribution of up to 3% of compensation or a 2% nonelective contribution for each eligible employee.
In 2015 and 2016, the maximum that can be contributed to a SIMPLE IRA is $12,500, with an additional $3,000 allowed for those employees age 50 years of age or older. SIMPLE IRA contributions can be made no later than the extended due date of the employee’s tax return.
- Payroll Deduction IRA
The Payroll Deduction IRA is one of the most simple retirement arrangements that a business can have. They are easy to set up and maintain, have low administrative costs, and any employer with one or more employees is eligible to provide them. Under a Payroll Deduction IRA, an employee forms an IRA (Traditional or Roth IRA) and authorizes a payroll deduction for the IRA. The employer’s role is to transmit the employee’s authorized deduction to the IRA account.
Payroll Deduction IRAs have the same income limits and phase-outs as other IRAs. For 2015 and 2016, contributions of up to $5,500 can be made with an additional $1,000 contribution available for those individuals over 50 years of age. 2015 contributions to an IRA must be made by April 15, 2016.
Choosing the best type of retirement plan for your business can be very complex. The above only provides a brief overview of the options available. Please feel free to contact us with any questions or concerns you may have in this regard at 858-558-9200.