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401(k) plans have been in existence since 1978 and have become a savings tool used by Americans today. These plans allow participants to save a percentage of their income up to an annual specified limit. For employees who are age 50 and up they can utilize a “catch up” provision and contribute a larger amount. (See below)

While it is not required, 401(k)s also allow the employer to contribute money to the employee’s account through a safe harbor contribution or a profit sharing plan. These features can be a way to attract and retain key talent as well as allow the business owners to save larger sums on a pre-tax basis for themselves.

A major benefit of the 401(k) has been the tax savings features. All contributions are made pre-tax which helps reduce the amount of taxes an employee has to pay today. Over time, any earnings from interest, capital gains or dividends grow tax deferred which allows the account to compound. The other tax savings option with a 401(k) is the Roth feature. This does not allow for pre-tax contributions but all earnings are tax free.

For employers who want to start a 401(k) plan the IRS has a tax credit to offset costs for starting up a plan and educate the employees. This credit is available for the first 3 years of plan operation. The government also created the savers credit for employees to encourage participation in retirement accounts. Some Americans qualify for this benefit and it allows for a tax refund or will reduce the tax owed simply because someone contributed money into their own retirement account.

When sponsoring a 401(k) it is important to understand what the rules and responsibilities will be in order to have a well-functioning plan. It is important the business owner understand their role as a fiduciary (LINK) and work with an advisor trained in the issues specific to business planning in general and qualified plans in specific.

You must being taking required minimum distributions from 401(k) plans no later than April 1 of the year after you reach 70 1/2. Distributions from regular 401(k) plans are taxed as ordinary income and may be subject to a 10% federal income tax penalty if withdrawn before 59 1/2, except in special circumstances such as disability or death.

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