A 408k plan is a retirement plan similar to a 401k but designed to meet the needs of smaller companies who want to offer a retirement benefit to their employees. 408k limits are also similar to that of a 401k, as is the 408k definition. While most traditional for-profit corporations consider offering a 401k retirement plan a necessary benefit to attract and keep good employees, many smaller companies may not find it feasible to do offer such a large-scale retirement plan, and a 408k plan allows them to offer something similar without the complication and expense of administering a 401k. The 408k can also be used for those who are self-employed and would otherwise not have access to a retirement plan.
408k Plan Definition
The term 408k refers to the IRS code that governs the plan, which is actually called the Simplified Employee Pension account, or SEP IRA. Like a 401k, the 408k allows employees and employers to make pre-tax deposits to the account, which continues to accrue interest tax-free until the money is withdrawn. The advantage of contributing money to the account prior to paying taxes is that it reduces a person’s taxable income for the year. To set up a 408k, the employer must complete a formal agreement with the employee using form 5305-SEP from the IRS. The separate account, called a SEP-IRA account, must be established for each participating employee.
The 408k plan is similar to but much simpler than a 401 (k). There are annual contribution limits of $16,500 with catch-up contribution allowances for employees over 50 of an additional $5,500 per year. Money that is contributed to the 408 (k) account cannot be withdrawn without penalty before age 59 ½. There are some allowances for which an employee can take a loan against their 408k plan but the funds must be repaid in the specified amount of time. If the money is not repaid, a 10% penalty will be assessed.
Eligibility for the 408k Plan
In order for an employee to be eligible to contribute to a 408k plan, he or she must have been employed by the company for three of the last five years and must have made at least $550 in the year in which contributions begin. The employee must be at least 21 years old and cannot be a resident alien or member of a union. A company who offers a 408 (k) must make it available to all eligible employees. The maximum amount that the employer can contribute to the 408k plan is $49,000 each year, however, all contributions are tax-free until withdrawn.
One of the strictest 408k plan rules is the limit on the number of employees participating companies are allowed to have. The 408k plan is only available to companies with fewer than 25 employees. It is also available to employees who are self-employed. Self-employed individuals who make contributions to a 408k plan are allowed to deduct the cost of the contributions, up to a specified amount, from their income. The amount allowed for the deduction depends upon the amount of self-employment tax due for the year.