Companies offer comprehensive retirement plans as part of their benefits packages to attract and retain top talent. These plans enhance employee satisfaction and allow businesses to shift compensation from salary to benefits, helping them reduce payroll taxes. Employees who participate in retirement plans can also lower their taxable income, making these plans a valuable part of overall compensation.
Qualified Retirement Plans
A qualified retirement plan is an employer-sponsored program that complies with the Internal Revenue Code (IRC) and the Employee Retirement Income Security Act (ERISA), making it eligible for specific tax advantages. These benefits can include tax deductions on employer and employee contributions and tax deferral on investment gains.
Qualified retirement plans come in two types: defined benefit plans, which guarantee a set payout at retirement, and defined contribution plans, where retirement savings depend on employee contributions and investment performance.
Employers offering qualified retirement plans for their employees can claim tax deductions for contributions made to these plans, subject to specific limits. These limits vary depending on the type of plan, with defined-benefit plans allowing for higher contribution limits compared to defined-contribution plans. Employees must also adhere to maximum contribution limits.
SIMPLEs and 401(k) plans are two affordable qualified retirement options employers can offer. As contribution limits continue to rise, now is the perfect time for businesses to consider adopting these plans.
Simplified Employee Pension Plans and SIMPLE Programs
A Simplified Employee Pension (SEP) is an IRA that employers or self-employed individuals can establish, offering tax-deductible contributions. SEP IRAs have higher contribution limits than standard IRAs and combine features of IRAs and 401(k)s with employer contributions and immediate vesting. Employer contributions cannot exceed the lesser of 25% of an employee’s compensation, or $69,000 in 2024.
SEP IRAs follow the same tax rules as traditional IRAs and offer identical investment options. Withdrawals from SEP IRAs in retirement are taxed as ordinary income, and the same transfer and rollover rules apply. Employers benefit from a tax deduction for any contributions to employees’ SEP IRA accounts.
Savings Incentive Match Plans for Employees (SIMPLEs) can be adopted by companies with 100 or fewer employees who earned at least $5,000 last year. SIMPLE programs can be designed as an IRA or a simplified 401(k) plan. The plan must be available to every employee who made at least $5,000 in the previous two years, and owner-employees are allowed to participate.
SIMPLE plans have contribution requirements and are not subject to nondiscrimination rules. The employer must match the contribution dollar for dollar, up to 3% of the employee’s compensation, or make an overall 2% contribution to every eligible participant. All contributions to a SIMPLE account are immediately fully vested.
Under the Setting Every Community up for Retirement Enhancement (SECURE) Act of 2019, small employers get a tax credit to offset the costs of starting a 401(k) plan or SIMPLE IRA with automatic enrollment.
Starting in 2024, the SECURE 2.0 Act allows employers without a retirement plan to establish “starter” 401(k) or 403(b) safe-harbor plans. These plans enable employees to contribute up to $6,000 annually (adjusted for inflation, with a $1,000 catch-up for those 50 and older) into a tax-advantaged account. Unlike traditional 401(k) plans, they reduce administrative burdens for employers, as no employer contributions or complex testing are required. A uniform contribution rate between 3% and 15% of compensation applies, and all eligible employees may participate, though they can opt-out.
401(K) PLANS
401(k) plans are qualified plans offered by many employers. Employees can contribute a certain percentage of their salary, as defined by the plan, or up to the contribution dollar limit, whichever is less.
For 2024, 401(k) contribution limits are set at $23,000, with workers over age 50 eligible to make an additional $7,500 catch-up contributions. If employers match contributions, the total amount, including catchups and employer matches, is capped at $76,500 for 2024.
Some employers match a portion of employee contributions and may also make additional contributions on behalf of employees. Self-employed taxpayers may make deductible contributions matching their plans. Employer contributions may be distributed according to the plan’s vesting schedule.
Employees who leave a job before being fully vested may not receive all the employer’s contributions. They will, however, always be 100% vested in the funds contributed and their earnings.
ROTH 401(K)S
A Roth option may be available to traditional 401(k) plans participants. Contributions are made after taxes, meaning taxable income is not reduced by the amount contributed. However, there is a significant tax advantage later, as withdrawals, including earnings, are tax- and penalty-free once the account holder reaches age 59½ and the account satisfies the five-year aging rule.
For 2024, the contribution limit for a designated Roth 401(k) is $23,000, with individuals aged 50 or older eligible to make additional catch-up contributions of up to $7,500. Eligibility to contribute to a Roth IRA in 2024 depends on your modified adjusted gross income (MAGI). Single filers with a MAGI below $146,000 and joint filers below $230,000 can contribute the full $7,000 (or $8,000 for those over 50).
Under the SECURE 2.0 Act, starting in 2024, Roth 401(k) account holders will no longer be required to take Required Minimum Distributions (RMDs), aligning Roth 401(k)s with Roth IRAs, which also have no RMD requirement in retirement.
A key benefit of a Roth IRA is that it has no required minimum distributions (RMDs) while the account holder is alive. If inherited by a spouse, no distributions or taxes are required, though non-spouse beneficiaries must take minimum withdrawals. The SECURE Act mandates that most non-spouses inheriting IRAs take distributions that fully withdraw the account within ten years.
The SECURE Act pushed back the age at which retirement plan participants must take required minimum distributions (RMDs) from 70½ to 72 and allows traditional IRA owners to keep making contributions indefinitely.
You may designate all or part of your elective 401(k) contributions as Roth contributions. However, matching contributions made by an employer must be invested in a traditional account, not a Roth. Participants in 401(k), 403(b), and 457(b) plans are permitted to roll over funds into Roth accounts within their plans, if available. Because contributions to traditional 401(k)s are made on a pre-tax basis, any funds transferred from traditional to Roth 401(k) accounts are taxed in the year of conversion.
Nonqualified Retirement Plans
Because qualified retirement plans often restrict the benefits a higher-paid employee can receive, nonqualified plans can be attractive. Nonqualified plans can cover only some employees. There are no compensation, benefit, or contribution limits other than an overall reasonableness test. The bookkeeping and reporting requirements are minimal. However, nonqualified plans do have some disadvantages.
The main drawback is that the benefits are unsecured—they are merely “promises to pay.” A company cannot formally set aside funds as future benefits. Assets intended for these benefits must remain general company assets and may be subject to a creditor’s claims. Another disadvantage is that payroll taxes are generally due when services are performed, not when compensation is paid. Finally, the employer does not receive a tax deduction until the benefits are actually paid to the covered employees.
Contact your tax manager/partner at 610-687-1600 or [email protected] for additional information.
Author Christine Fisher-Guyer, CPA, Partner, has provided top-notch accounting services to Stephano Slack’s clients. She currently manages tax auditing and accounting operations at the firm and is an excellent problem solver, especially regarding client concerns. Chris can be contacted at 610-710-4729 or [email protected]
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