What Is A 401(k)?

bizguide What is 401 (K)?

Setting Up a 401(K) plan for your business is not mandatory. However, it may soon be approved by the IRS with the premise that employers provide congruous notice to employees with an option to “opt-out” of mandatory pre-tax contributions.

While some employers question the importance of offering a retirement plan for their workers, a recent study has shown that 94% of the small business owners are realizing the importance of offering a 401(K) plan in recruiting and retaining employees.

Furthermore, attracting quality employees are likely to consider working for a company that cares to invest in their workers by offering retirement benefits the longer that they stay with the company.

What is a 401(K) plan and how does it work?

A 401(K) plan is a retirement plan offered by employers and companies to eligible employees where a portion of an employee’s salary is deducted before or after taxes, depending on the arrangement. This savings plan is sponsored by an employer and it offers benefits to the business and its employees.

Benefits to employees

  • Financial security on retirement
  • Compounds interest over time
  • Offers Tax Credit (Saver’s Tax Credit)
  • Easy contributions through payroll deductions
  • Assets on retirement can be transferred to another employer
  • Contributions made by employees may reduce present taxable income
  • Profit on investment and contributions are not taxed until it is distributed

Benefits to business owners

  • Attracts and retains employees
  • Availability of flexible plan options
  • Plan assets grow without free of taxes
  • Credits on taxes and other incentives help to reduce cost
  • Contributions made by employers are deductible against taxes

How does it work?

Though employers are the only ones who are qualified to sponsor a 401(K), employees are the ones deciding the amount to be deducted from their salary. The deducted amount then goes to the employees 401(K), based on the limitations and provisions of the plan based on the rules set by the IRS. The plan sponsor (the employer) may also contribute to the employee’s plan as an option.

Employer’s responsibility

  • Runs the retirement plan in accordance with the law, plan provisions, rules, and regulations
  • Sets the eligibility for the plan and the employee amount to contribute
  • Searching for vendors to run the plan and its features
  • Sets the amount of contribution towards employees plan
  • Choosing the investment options and the frequency of reallocating investment assets

Employee’s responsibility

  • Decide to participate in the 401(K) plan
  • Read and understand the summary plan description (SPD)
  • Choose the amount of contribution per pay period

Types of 401(K) Plans

There are Six (6) types of retirement plans which allows pre-tax payments by employers and or employees in annual contributions ranging from $6000 to $56000 or more.

  • Traditional 401(K) – Best for owners having more than eight (8) employees
  • Safe Harbor 401(K) – Suitable for high-earning employers with more than eight (8) employees who are willing to pay more compared to a traditional 401 (K)
  • Solo 401(K) – Ideal for self-employed business owners that are interested in alternative investments
  • SIMPLE IRA – Perfect for small businesses who are interested in the structure of a 401(K) at an inexpensive cost with contribution limits that are lower
  • SEP IRA – Applicable for businesses having less than 3 to 5 employees who are responsible for funding their contributions
  • Traditional IRA – Best for independent contractors who are wanting to save more funds for retirement on an annual basis

Related Article: How to Set Up A 401(K) Plan For Your Las Vegas Business

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