With a 401(k) plan, employees can choose to defer a portion of their salary. So, instead of receiving that amount in their paycheck today, the employees can contribute it to a 401(k) plan sponsored by their employer. These deferrals are placed in the plan’s retirement trust in an account for each participant.
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Pros:
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Allows employees an easy way to save for their retirement
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Can be combined with or amended to include employer contributions
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Provides the employer with the ability to contribute on a discretionary basis
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Cons
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Depending on how the investments are handled, the plan’s administrative costs can be significantly larger than other plan types
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Subject to compliance testing to show that benefits do not favor the higher paid employees
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401(k) plans have become a widely accepted retirement savings vehicle for small businesses. Currently, more than 15 percent of the US population contributes to an employer sponsored 401(k) plan and, as a group, they hold several trillion dollars in retirement plan assets.
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An employees’ deferral can be made on either a Pre-Tax or Roth (After-Tax) basis as directed by the employee. In addition to the Roth option, 401(k) plans can also offer Employee After Tax contributions which, if the plan allows, can later be converted to a Roth style plan account.
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Many 401(k) plans provide for employer matching or other contributions. The Federal Government and most state governments do not tax employer contributions and pre-tax deferrals (plus earnings) until distributed. Most employers hire a Third Party Plan Administrator for their 401(k) Plans to help reduce their administrative burden.
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If you establish a 401(k) Plan, the Employer:
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Can be a business of any size
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May have additional retirement plans if it so chooses
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Must create a governing plan document
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Must decide whether the employees will invest their own funds or if the employer will handle this task
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Must choose if it wants to make employer contributions in addition to employee salary deferrals
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May need to file a form in the IRS Form 5500 Series
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Who contributes
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Employees contribute through a salary deferral feature. The plan may be set up to allow for additional employer contributions.
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Contribution limits
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Employees may contribute the lesser of 100% of compensation or $18,500 (for 2018, subject to cost-of-living adjustments for later years). Employees aged 50 years and over may contribute an additional “catch-up contribution” of $6,000. Employer contributions are limited as well in the same fashion as a normal profit sharing plan.