401(k) and Other salary Savings Plans Chapter 23

I. Introduction In general, a salary savings plan is a plan that gives the employees the choice whether to receive a part of their compensation in cash or to contribute it to a qualified plan

Popularity can be explained: –No funding commitment by the employer –Cost to the employer is min –No long-term liability for employer –High portability –amount of savings is discretionary –could be simple to administer

II. 401(k) Plans (CODA) Employees agree to a salary reduction that is contributed to a qualified plan. It could be an independent plan or included with regular profit-sharing, savings or stock bonus plan. Section 401(k) plans can be adopted only by private employers and tax-exempt organizations.

Advantages and Disadvantages: –Tax-deferred savings meduim –Employee can choose the amount of contribution –Similar to IRAs easy to understand –attractive for employers –Design of the plan may save the employer money

$14,000 limit contribution is small compared to other plans Qualified plan is more complicated than individual savings vehicle Employer’s deduction is limited to 25% of covered payroll Deferral amounts must be 100% vested

Features of 401(k) plans: salary reduction must be made before the beginning of the year Employer makes a matching contribution to the plan Employer participation is not a requirement for 401(k) plan.

Plan may permit employees to make additional after-tax contributions. 401(k) plan must meet all the eligibility and coverage requirements for qualified plan Vesting: nontaxable employee salary reductions must be immediately 100% vested –employer contributions must meet the usual vesting rules

limit $14,000 contribution is imposed on all 401(k) plans, 403(b) and SIMPLEs ADP tests must be met: failure will cause the plan to disqualify Distributions: not before age 59 1/2 except upon death, disability, separation from separation. –10% early withdrawal penalty

FICA and FUTA are withheld

III. SIMPLEs Definition:Non-qualified salary savings plan where contributions are made to the participating employee’s IRA Employee’s contribution cannot exceed $10,000 /year Eligible employers: –100 or fewer employees –employer does not maintain a qualified plan

Advantages: –can be established by filling an IRS form –benefits are portable 100% vested –Accounts are owned by employees –Employees benefit from good investment Disadvantages: –SIMPLEs cannot be the only source of retirement income

Benefits are not adequate if employee does not make significant contributions Contribution limit = $10,000 / year Employer is required to make contribution equal to either –(a) a $-to-$ matching contribution up to 3% –(b) 2% of compensation for all eligible employees

Each employee must maintain an IRA Both salary reduction and employer contribution are not included in the employee’s taxable income. Employee contributions are subject to FICA and FUTA Distributions are subject to the same restrictions as IRA

IV. 403(b) Tax-Deferred Annuity Plans Designed for tax-exempt organizations as a supplement to qualified plan. Eligible employees as defined in Section 501©(3) Part-time or full time employee. Distributions from 403(b) plans are subject to the same rules as 401(k)

Withdrawals are not permitted before age 59 1/2 403(b) plans have loan provisions Taxation: same tax advantages as qualified plan Upon distribution the full amount is taxable either during employment or at termination of service.

Contribution limits: Max = lesser of two amounts: (1) the exclusion allowance for a given year and (2) $40,000-or-100-percent- of-income defined contribution limit. $14,000 limit applies to the salary reduction

V. Section 457 Plans Designed as a salary savings arrangement for governmental employers Limit = $9,000 /year or 1/3 of the employee taxable compensation.