Employer-established retirement plans let employers save more
In Hawaii, many small businesses offer retirement plans to attract and retain employees.
The advantage of employer-established retirement plans is that they offer higher contribution limits than self-established plans. This gives employees the opportunity to save more towards their retirements.
There are several different types of employer-established retirement plans. Each has different tax implications.
The following are a few examples of employer-established retirement plans: 401(k) plan, Roth 401(k), SIMPLE 401(k) and SEP IRA plan. Each is subject to different enrollment rules.
» Individuals who participate in a regular 401(k) plan may contribute up to $15,500 of pretax income for 2007 and 2008. Individuals who are at least 50 years of age may make additional contributions of $5,000. Contributions that exceed the annual limit will suffer a 10 percent penalty. Distributions from a 401(k) are taxable to the employee.
» Roth 401(k) plans allow the employee to make contributions of after-tax income. The annual contribution limits are the same as the regular 401(k) plan. Since contributions into a Roth 401(k) are subject to tax, distributions from the plan may not be taxable if certain requirements are met.
» For employers with 100 employees or fewer that earned at least $5,000 each of the two preceding years, they are eligible to establish a SIMPLE 401(k) plan. The employer is allowed to make contributions only to the SIMPLE 401(k) plan.
Employees can also make contributions up to $10,500 for 2007 and 2008 into a SIMPLE 401(k) plan. Individuals who are at least 50 years of age may make an additional contribution of $2,500 to the plan.
Employers sponsoring a SIMPLE 401(k) plan must either match employee contributions, limited to 3 percent of the employee's compensation, or make non-elective contributions of 2 percent of compensation for each eligible employee.
» Employers also have the option to establish a SEP (Simplified Employee Pension) IRA Plan for employees.
In a SEP IRA plan, the employer can make a contribution that is limited to the lesser of 25 percent of the employee's compensation for the year (for compensation up to $225,000 in 2007 and $230,000 in 2008) or $45,000 for 2007 and $46,000 for 2008. If the employer doesn't make the full allowable contribution, employees may contribute to the plan, subject to the same contribution limits as traditional and Roth IRAs.
Employees can contribute up to $4,000 for 2007 and $5,000 for 2008 ($5,000 and $6,000 if catch- up contributions are allowed). Distributions from a SEP IRA are taxed similar to how traditional IRAs are taxed.
Distributions that are funded by the employer are generally includable in the employee's taxable income.
If employer-established retirement accounts are partially funded by the employer and partially by the employee with after-tax money, an exclusion ratio is used to determine the employer-funded portion that is taxable.
Hawaii small business owners have many alternatives for retirement savings plans for themselves and their employees. Knowing the alternatives begins the dialogue.
Ken Kretzer is a senior tax manager for the Honolulu office of Grant Thornton LLP. He can be reached at firstname.lastname@example.org