What a plan 408 (k)?
A 408 (k) account, commonly known as a simplified employee pension plan (PSE), is an employer-sponsored retirement savings plan. The 408 (k) plan is a simplified version of the popular 401 (k) plan; however, it is intended for small businesses, such as those with fewer than 25 employees. It is also accessible to the self-employed. The plan allows employees to put pre-tax dollars into the account, thereby reducing their net income for the year. This results in tax savings for the contributor.
Key points to remember
- A 408 (k), also known as a simplified employee pension (PSE), is an employer-sponsored pension plan similar to 401 (k).
- The 408 (k) plan is accessible to companies with 25 or fewer employees.
- Only employer contributions are allowed in the 408 (k) plan.
- 408 (k) plans are available to the self-employed, who are subject to the same contribution limits as employers.
Understanding a 408 (k) plan
Although the term 408 (k) is often used to describe an account, it refers to the Internal Revenue Code, which details the simplified employee pension accounts (MS) and reduced wages simplified (SARSEP) (defined in IRC 408 (k) (6)). Employees are not allowed to contribute to the plan established by their employer. Throughout the life of the account, deposits are not treated as income until the funds are withdrawn.
Participants who have self-employment income and work for an employer can contribute to a 408 (k) and participate in their employer’s pension plan. The annual employer contributions can not exceed the lesser of 25% of the employee’s salary or $ 57,000 for 2020 (against $ 56,000 for 2019. The annual compensation limit can not be calculated on income exceeding $ 285,000 for 2020 (versus $ 280,000 in 2019) The maximum deduction claimed on a professional tax return for contributions is the lesser of the total contributions in the employees’ accounts or 25% of the remuneration.
Plan 408 (k) Plan vs. 401 (k)
Participation in traditional 401 (k) plans continues to grow. As of December 2020, there were 55 million active participants in 401 (k) plans, holding $ 5.3 trillion in assets. When criticized for its high fees and limited options, reforming the 401 (k) plan brought several changes to the benefit of employees. The 401 (k) Medium Plan offers nearly two dozen investment options – balancing risk and reward – depending on employee preferences. Unlike a SEP, employees can contribute to a 401 (k) plan, and they remain a popular retirement savings option for companies with more than 25 employees.
At the same time, fund expenses and management fees have remained stable or decreased, making this option possible for more Americans. Additional features, such as automatic enrollment, increased fee transparency, additional low-cost index fund options and catch-up contributions for near-retirees have been added to many plans. Contribution limits are indexed to inflation, allowing members to make larger contributions to the plans over time. However, a better and more widespread understanding of the 401 (k) through education and disclosure initiatives will continue to stimulate participation in the 401 (k) and 408 (k) plans.
While 401 (k) is funded with pre-tax dollars (resulting in a tax on subsequent withdrawals), a Roth 401 (k) is another type of investment savings account sponsored by the employer funded with after-tax money. This means that when an employee withdraws funds at the appropriate time, they will not pay tax. However, if an employee withdraws contributions before the age of 59 and a half, he may be liable for taxes as well as a 10% early withdrawal penalty. This early withdrawal penalty applies to traditional and Roth 401 (k) plans and 408 (k) plans. However, the Roth 401 (k) is well suited for people who think they will be in a higher tax bracket in retirement.