401k Plans - Cash or Deferred Arrangements 401(k) Plan is also occasionally known as cash or deferred arrangement (CODA) plans. The 401(k) is a qualified defined contribution plan named from IRS Code, 401k, under which it operates. It is a plan in which an employer permits an employee to defer receipt of some income by contributing it into the 401(k) plan. These contributions are made on a pre-tax basis. All contributions and earnings are untaxed until withdrawn from the plan.
Many 401(k) plans include a matching contribution from the employer according to a set formula, such as 50% of the employee’s contribution with up to a maximum of 6% of compensation. Employers may also make contributions to an employee’s account independent of the employee’s contribution, as in the case of a profit sharing plan.
Participant Contributions - In 2004, a participant’s pre-tax contributions were limited to either of 25% of the individual’s compensation or $13,000. Many plans can, and will, impose a lower percentage limit on the individual’s contributions. The annual maximum individual contribution for 2007 was $15,500. In 2008 and after, the $15,500 limit will increase in $500 increments if the effects of inflation indicate such an increase is needed.
Catch-up contributions - In addition to the normal contribution limits, those over the age of 50 may make an additional “catch-up” contribution of $5,000 per year.
Investment Options - A 401(k) plan generally offers the participants a wide range of opportunities to direct their account contributions to a broad range of investment options from conservative risk to aggressive risk. These options may include institutional or mutual funds investing in the money market, bond market, or stock market; annuities; guaranteed investment contracts (GICs); company stock; and self-directed brokerage accounts.
Withdrawals - In general, a 401(k) plan limits withdrawals of assets to five occasions: termination from employment, disability, reaching the age of 59 1/2, retirement, and death. Additionally, the plan may optionally include provisions for loans and/or hardship withdrawals.
Tax-Sheltered Annuities (403(b) Plans
These plans are also known as a tax-sheltered or a tax-deferred annuity program. This plan is for employees of educational, religious, and charitable (501(c) (3)) organization to save for their retirement. It operates under similar maximum contribution rules and withdrawal privileges as a 401(k) plan. Like the 401(k), pre-tax contributions and all earnings remain tax free until withdrawn. A plan participant may contribute up to 100% of pay or the annual dollar limit in 2007: $15,500 per year.
Investment options - There are two principal differences between a 401(k) and 403(b) plan. Investment options in the 403(b) plan are limited to annuities and mutual funds only. The plan permits additional contributions under certain conditions that would otherwise exceed the normal annual contribution limits. Just like a 401k the 403(b) plan participants who are age 50 or older may make an additional “catch-up” contribution of $5,000 each year.
Roth IRA 403B - In 2006, 403(b) plans may now contribute into a Roth IRA 403(b) account. The decision to offer such a plan is entirely up to the employer. Under the new IRS rules, contributions to the Roth-403(b) account will be taxed current year as income, but the future distributions from that account will not be taxed. These contributions to a Roth IRA 403(b) account may be made up to the maximum of $15,000 year.
IRC(Internal Revenue Code) Section 457 Deferred Compensation Plans
A 457 plan is a non-qualified retirement plan established for the benefit of state and local government employees or the employees of a tax-exempt organization. Until withdrawn, 457 plan contributions and all its earnings remain untaxed. Contribution limits in 2007 are $15,500 per year.
Catch-Up contributions - In addition to the normal contribution limits those over the age of 50 may make an additional “catch-up” contribution in 2007 of $5,500.
3 years before retirement - The catch-up provision if over 50 three years prior to retirement will allowable maximum contributions to double. This means that in 2004, if you’re planning retirement at the end of 2007, your maximum contribution could total $30,000. Plan distributions may occur at retirement, termination, unforeseeable emergency, and at death.
Distributions may be taken as a lump sum, in annual installments, or as an annuity. Proceeds from a governmental 457 plan may be transferred to an IRA or a new employer’s 401(k), 403(b) or 457 plan that accepts transfers from an old employer’s plan. On withdrawal from an IRA or from the new plan, the distribution will be subject to immediate taxation at ordinary income tax rates.
Qualified Plans for Small Employer
Keogh (HR-10) Plan
Keogh - HR10 Plan is a qualified retirement plan established by The Self Employed Individuals Tax Retirement Act of 1962, otherwise known as the Keogh Act, or HR-10. Keogh plans may be set up by self-employed persons, partnerships, and owners of unincorporated businesses as either a defined benefit or defined contribution plan. As defined contribution plans, they may be structured as a profit sharing, a money purchase, or a combined profit sharing/money purchase plan.
Contributions are limited to $40,000, with subsequent adjustments for inflation in $1,000 increments thereafter.
Keogh plans may not authorize loans. Contributions and all earnings accumulate free of tax until withdrawn, generally at retirement. In general, withdrawals prior to age 59 1/2 are subject to a 10% premature distribution penalty in addition to ordinary income tax; however early distributions can be transferred to an IRA without penalty.
Simplified Employee Pension (SEP)
A SEP is a retirement plan designed for self-employed persons, partnerships, sole proprietors, independent contractors, and owner-employees of an unincorporated trade or business; however, any type of business may set it up a SEP.
A SEP is an easy way for a small employer to establish a retirement plan for employees without the complex administration and expense found in qualified retirement plans. In fact, an employer may establish a SEP only if the employer has no qualified retirement plan in effect. Under a SEP, the employer may make a contribution of up to either 15% or $30,000 of compensation to IRAs established in each employee’s name. Hence, such an arrangement is known as a SEP-IRA. When made, these contributions are owned in their entirety by the employee, and they may be withdrawn and/or transferred by the employee at any time. Contributions to a SEP by the employer are discretionary, but must be deposited into each eligible employee’s IRA when made. Because these accounts are IRAs, the amounts therein are subject to all IRA rules regarding transfer, withdrawal and taxation.
SIMPLE
Established by the Small Business Protection Act of 1996, a SIMPLE may be set up by employers who have no other retirement plan and who have 100 or fewer employees with at least $5,000 in compensation for the previous year. They may be structured as an IRA or as a 401(k) plan. In 2008 employees may defer any percentage of compensation up to $10,500 per year to the SIMPLE, and the employer is required to make a matching contribution of up to 3% of the employee’s pay based on that election. The employer may reduce the maximum matching percentage in any two years out of five. Alternatively, the employer may establish a uniform 2% of salary contribution per year for all eligible employees regardless of whether they contribute to the SIMPLE or not. Thereafter, the $10,500 limit will increase in $500 increments whenever the cumulative effects of inflation indicate such a rise is needed.
Catch-UP Contributions - In addition to the normal contribution limits outlined above, starting those over the age of 50 may make an additional “catch-up” contribution of $3,000 in 2007. After 2007 the “catch-up” limit will increase in $500 increments whenever the cumulative effects of inflation indicate such a rise is needed.
Vesting - Contributions are immediately vested with the employee, and deposits and earnings in the account will accumulate tax free until withdrawn. In general, distributions from a SIMPLE are taxed like those from an IRA. Withdrawals prior to age 59 1/2 are subject to the 10% early withdrawal excise tax in addition to ordinary income tax.
Penalty Assessment - Unlike an IRA or SEP, however, employees who withdraw money from a SIMPLE IRA within two years of their first participation in the plan will be assessed a 25% penalty tax on such withdrawals instead of 10%. This extra penalty does not apply to early withdrawals from a SIMPLE 401(k). Distributions from both types of SIMPLE may be transferred to another SIMPLE or to an IRA, but they are ineligible for transfer to a qualified retirement plan.
Individual Retirement Plans
An Individual Retirement Arrangement (IRA), commonly called an Individual Retirement Account, is a personal retirement savings plan available to anyone, regardless of age, who receives taxable income. Husbands and wives may each have an IRA, even if one person in that marriage is not working. A person’s annual contribution is limited to $5,000 for tax year 2008.
Contribution Maximums for 2008 SEP IRA’s - 25% of your wages (or up to 20% of your Schedule C income) up to a maximum of $46,000 for 2008.
SIMPLE IRA’s - $10,500 salary deferral plus $2,500 catch-up if you are age 50 or over up to 3% of your salary matched by your employer (2.192% if you are self-employed). Self-employed individuals are eligible for salary deferral contributions.
Profit Sharing/401(k)’s - $15,500 in 2008 plus catch-up deferral of $5,000 if you are age 50 or over plus 25% of your wages (or 20% of your Schedule C income) up to a maximum of $45,000 for 2008. Salary deferral contributions for the self-employed (in addition to the employer profit sharing contributions) can be made if the tax return has been extended up until your tax filing deadline for 2008.
Coverdell ESA’s - $2,000 per year until the child is age 18. Health Savings Accounts - $2,900 for individual coverage in 2008 and $5,800 for family coverage in 2008 plus $900 catch-up for 2008 for persons age 55 to 65.
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Contributor's Note
I have prepared more than 500 federal tax returns for clients. Previous years figures are included, because you can amend previous returns, for 3 years.
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