408 (k) account, commonly referred to as an Employee Simplified Pension Plan (SEP), is an employer-sponsored retirement plan. The 408 (k)-Plan is the SEP version of the popular 401 (k) plan. A SEP is intended for small businesses, for example those with less than 25 employees.
The SEP-IRA only allows the employer to make contributions to the plan, while employee contributions are not allowed. This type of plan is also available for the self-employed and sole proprietorships.
look at a glance
— A 408 (k), also known as an employee simplified pension
(SEP), is an employer-sponsored retirement plan that is similar to a 401 (k).
— The 408 (k)-plan is available for organizations with 25
or fewer employees.
— Only employer contributions are allowed in the 408 (k)-scheme.
— 408 (k) plans are available for the self-employed with the same
contribution limits as employers.
Realizing a 408(k) Plan
Although the term 408 (k) is widely used to describe an account, it refers to the Internal Revenue Code (IRC), Employee Simplified Pension (SEP), and Employee Simplified Pension (SARSEP) accounts (defined in IRC 408 (k) (6)). Employees are prohibited from contributing to the plan established by their employer. During the life of the account, deposits will not be treated as income until funds are withdrawn.
Participants who have self-employed income and work for an employer can contribute to a 408 (k) and participate in their employer’s pension plan. Annual employer contributions cannot exceed the least of 25% of employees’ wages or $58,000 for 2021 (compared to $57,000 for 2020). The annual compensation limit cannot be calculated for income over $290,000 for 2021 (compared to $285,000 in 2020). The maximum deduction of contributions to the business tax return is the lower amount of total contributions on the accounts of employee or 25% of salary.
408(k) Plan vs. 401(k) Plan
Participation in traditional 401 (k) plans continue to grow. According to Morningstar, 43% of all workers had a defined contribution plan like 401 (k) in 2019, and there were $6.4 trillion in assets in 401 (k) plans.
Once criticized for its high fees and limited options, the 401 (k) Reform Plan brought several changes in favor of workers. Average 401(k) – The plan offers nearly 24 investment options (balance between risk and reward) based on employee preferences. Unlike a SEP, employees can contribute to a 401 (k) plan, and they remain a popular retirement option for companies with more than 25 employees.
Feasible for More Americans
At the same time, fund expenses and management fees have remained the same or have decreased, making this option possible for more Americans. Many plans have been expanded to include additional features like automatic enrollment, increased fee transparency, additional low-cost index fund options, and catch-up contributions for near retirees.
Contribution limits are indexed to inflation so that members can make larger contributions to plans over time. Nonetheless, a better and broader understanding of 401 (k) through education and disclosure initiatives will further fuel participation.
While the 401 (k) plan is funded with pre-tax dollars (resulting in a tax levy on withdrawals), a Roth 401 (k) is another type of employer-sponsored investment savings account that is funded with after-tax money. This means that if an employee withdraws money at the right time, they will not pay taxes.
However, if an employee makes contributions before the age of 59.5, they may be taxable with a 10% prepayment penalty. This prepayment penalty applies to traditional and Roth 401 (k) plans and 408 (k) plans. However, the Roth 401 (k) is well suited for people who think they are in a higher tax bracket when they reach retirement age.