What Is a 408(k) Plan?
Let me explain what a 408(k) plan is. It's an employer-sponsored retirement savings plan where you, as an employee, can set aside pretax dollars that grow tax-deferred until you withdraw them after age 59½. This makes it a form of individual retirement account (IRA), and you'll pay taxes on those withdrawals. Commonly, people call it a simplified employee pension (SEP) plan—think of it as the SEP version of the well-known 401(k).
Key Takeaways
Here's what you need to know right away. A 408(k) functions much like a 401(k) as an employer-sponsored retirement plan. It's also known as a simplified employee pension, which is essentially an IRA. This plan is open to companies of any size and self-employed people, all under the same contribution rules. Remember, only employers contribute—no employee contributions allowed. The IRS sets limits on how much employers can put in.
Understanding 408(k) Plans
Section 408(k) of the Internal Revenue Code lays out the rules for SEP and salary reduction SEP (SARSEP) accounts, which are IRAs or annuities. That's why we often refer to SEP plans as 408(k) plans.
To participate, you need to meet certain requirements. These plans are for small businesses and self-employed individuals. You're eligible if you're over 21, have worked for the employer at least three of the last five years, and earned at least $650 in 2022 (that jumps to $750 in 2023).
Employers' annual contributions can't exceed the lesser of 25% of your pay or $61,000 for 2022 ($66,000 in 2023). Compensation for this calculation is capped at $305,000 in 2022 ($330,000 in 2023). The business can deduct the lesser of total contributions or 25% of compensation on its tax return.
You can withdraw from your 408(k) anytime, just like a traditional IRA, but conditions apply. Most people wait until 59½ to avoid a 10% penalty. Required minimum distributions start April 1 the year after you turn 72 (if you hit that before Dec. 31, 2022) or 73 (if after Jan. 1, 2023).
Fast Fact
Unlike traditional retirement plans, SEPs come without the usual start-up or administrative costs, which makes them straightforward for you to set up.
408(k) Plans vs. 401(k) Plans
As I mentioned, a 408(k) is one kind of employer-sponsored plan, but the 401(k) is the most popular, offered by most U.S. companies. With a 401(k), you contribute pretax via payroll, and employers might match. Recent reforms have cut fees and expanded investment choices—averaging over two dozen options to match your risk preferences.
Unlike SEPs, you as an employee can contribute to a 401(k). Self-employed folks or couples can use a solo 401(k) with the same limits as employer plans. Participation in 401(k)s is huge, with $6.3 trillion in assets by September 2022, covering over half the U.S. retirement market and 60 million participants.
Contribution limits for 401(k)s adjust for inflation: $20,500 in 2022, up to $22,500 in 2023, plus catch-up of $6,500 ($7,500 in 2023) if you're 50+. Early withdrawals before 59½ hit a 10% penalty unless exempted, and taxes apply since contributions are pretax. RMDs start at 72 for those turning that age by end of 2022, or 73 under SECURE ACT 2.0 for later.
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