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| Steven King, CFP, MBA, AAMS 4555 Holland Street Wheat Ridge, Colorado 80033 303-420-8804 Toll Free: 877-420-8804 fax: 303-420-8805 sking@1stallied.com |
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| iiRetirement Plans for Business: 401(k) Plans |
| Retirement Plans Financial Planning Investments |
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| Securities offered through FIRST ALLIED SECURITIES, INC. member |
| Is a 401(k) Retirement Plan right for your business? ____________________________________________________________ This document is an introduction only and is not intended as advice. A detailed analysis of your circumstances would be required to determine your suitability for this or any other retirement plan. Numerous technicalities have been omitted from this introduction in order to improve readability. Some of these technicalities may have consequence for your situation. See the Home Page of this website for further disclaimers. ---------------------------------------------------------------------------------------------------------------------------------------------------- 401(k) Plan: The “Full-Feature” Retirement Plan for Businesses There are two types of 401(k) retirement plan, the Money Purchase Plan or Profit-sharing Plan. Both are more complex, but more flexible, than the SEP, and SIMPLE* retirement plans. Advantages for the employer: 1. Tax deductible contributions 2. Right to skew the plan in favor of long-term employees. 3. Employer contributions are discretionary for the Profit-sharing plam 4. High limits on contributions Disadvantages: 1. Complex IRS reporting requirements, including discrimination testing 2. Third party plan administrators can add cost Advantages for the employee: 1. Self-directed accounts 2. Tax-deferred growth 3. Incentivized savings 4. Emergency liquidity for hardships * technically, a SIMPLE is also a 401(k) plan, but it is not commonly referred to as such Tax advantages For employer: Contributions are current expense items For employee: Employer and employee contributions and all gains are currently excludable. Eligible Employers Any business, whether incorporated, partnership, limited liability company, or sole proprietorship, is eligible. Tax-exempt employers are eligible as well. Employee Eligibility The employer sets the employee eligibility rules when adopting the plan. The employer may exclude non-resident aliens, workers covered by a collective bargaining agreement, and workers under the age of 21. The employer may exclude employees who have been employed for less than one year. Total Annual Contributions Contributions can come from three sources, Employee elective deferrals, Employer Match, and Employer Profit Sharing. Total Contributions, per employee per year cannot exceed $40,000*, or 100% of pay, whichever is less. * 2004: $41,000 Maximum Applicable Pay For purposes of calculating any plan purpose, the maximum pay is assumed to be $200,000, regardless of actual pay. Employee Contributions The employee must establish their elective deferral schedule prior to receiving pay. An employee may elect to defer up to $12,000* per year to his or her 401(k) account as a salary reduction. *2004: $13000, 2005: $14000, 2006: $15,000 For employees over age 50, there is a separate “catch up” allowance of $3000** per year. **2005 $3000, 2006 $5,000 Employer Contributions Money Purchase Plan At adoption, the plan defines the annual contribution. Thereafter, the employer must make the contribution, regardless of the business’ profitability. Profit Sharing Plan Matching Contributions The employer makes a contribution that is a function of employees’ deferral. The employer has wide flexibility in selecting a formula for matching contributions. This need not be established until the end of the year. Profit Sharing Contributions The employer makes a contribution that is independent of employees’ deferral. The employer has wide flexibility in selecting an amount, which may be a lump sum, or a percentage of pay. This need not be established until the end of the year. The company may forgo any contribution, or it may make a contribution despite an absence of company profits. Deductibility All annual contributions are deductible to the business for income tax purposes. However, the employers’ deduction is limited to 25% of total compensation of all employees, (calculated before elective deferral.) Interest or gains earned within the plan are excluded from taxable income. Adopting a Written Plan A plan must be in writing, and communicated to the employees. Because the plan must be approved by the IRS, most businesses use a “master” or “prototype” plan offered by a custodian, who has already obtained IRS approval. Loans A 401(k) plan is not required to permit participant loans. However, it can permit loans that meet certain IRS requirements. Typically, the borrower signs a note, and makes repayments of principal and interest, usually through payroll deductions. Obviously, this adds complications for the employer’s payroll process. General requirement of such loans include: Max loan amount is the lower of $50,000, or half of vested balance. Max loan term is 5 years No less than quarterly repayments Must bear “reasonable” rate of interest Distributions Distributions from a 401(k) plan are not permitted except in cases of: seperation from service, death, disability, age 59 ½, termination of the Plan.Additionally, a plan may permit distribution in the event a participant experiences a hardship, such as, family medical expenses, purchase of home, post secondary education, prevent foreclosure on home mortgage. Distributions prior to age 59 ½ are subject to a 10% IRS penalty, payable by participant. Vesting Among the most important distinctions between a 401(k) and other retirement plans is “vesting rights.” The plan may adopt a vesting schedule, whereby an employee obtains rights to employer contributions gradually. The employee always has full rights to his/her own deferrals. If an employee leaves the plan prior to full vesting, the “unvested” portion of their allocated share of the plan is reallocated to the remaining members of the plan. By this mechanism, long-term employees acquire the assets of “short timers,” allowing the employer to reward employee loyalty. Discrimination Testing 401(k) plans are subject to annual testing to verify that the plan’s benefits are balanced between “highly compensated employees” and “non-highly compensated employees.” These tests are complex, and beyond the scope of this introduction. For more information, see Ongoing Responsibilities of the Employer The plan sponsor assumes numerous administrative responsibilities. These burdens can usually be outsourced. Communicating with participants Monitoring investment options Processing distributions Nondiscrimination testing Administering loans Delivering regular statements Record keeping and IRS reporting Answering participant questions |
| "401(k) Discrimination Testing”. |