Who can participate in a 403(b) plan?
Eligible employees of Code Section 501(c)(3) tax-exempt organizations;
Eligible employees of public school systems. A public school system is defined in Code Section 170(b)(1)(A)(ii) as an education organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly conducted. Included in this category are employees of:
- Public schools
- State colleges
Eligible employees of churches;
Employees of public school systems organized by Indian tribal governments;
Ministers employed by Code Section 501(c)(3) organizations;
Self-employed ministers, treated as employed by a tax-exempt organization that is a qualified employer; and Ministers (chaplains) who meet both the following requirements:
They are employed by organizations that are not Code Section 501(c)(3) tax-exempt organizations, and They function as ministers in their day-to-day professional responsibilities with their employers.
What Is a 401(k)?
A 401(k) is a retirement savings plan sponsored by an employer. It lets workers save and invest a piece of their paycheck before taxes are taken out. Taxes aren’t paid until the money is withdrawn from the account.
401(k) plans, named for the section of the tax code that governs them, arose during the 1980s as a supplement to pensions. Most employers used to offer pension funds. Pension funds were managed by the employer and they paid out a steady income over the course of the retirement. (If you have a government job or a strong union, you may might still be eligible for a pension.) But as the cost of running pensions escalated, employers started replacing them with 401(k)s.
With a 401(k), you control how your money is invested. Most plans offer a spread of mutual funds composed of stocks, bonds, and money market investments. The most popular option tends to be target-date funds, a combination of stocks and bonds that gradually become more conservative as you reach retirement.
Simplified Employee Pensions (SEP)
Q: Can I start a retirement plan for my business now and get a deduction for 2020?
A: Yes, you can start a SEP any time before filing your 2020 tax return, and take a deduction for 2020. SEPs are simple to set up and maintain and require no filings with the DOL or IRS. However, you must cover all of your employees who meet the eligibility requirements. Eligibility is established by you on the SEP document. You must contribute the same percentage of pay for all eligible employees.
Example 1: ABC Supply Company, Inc. has 3 employees. The owner, Shonda, establishes a SEP by completing IRS Form 5305-SEP. She requires employees be at least age 21 and have worked for her at least 1 year. Two of her 3 employees meet these requirements, so she establishes SEP-IRAs for herself and her 2 eligible employees. Shonda contributes 10% of her 2020 compensation to her SEP-IRA, so she must also contribute 10% of their compensation to each of the 2 eligible employees SEP-IRAs. Shonda has completed this by March 15, 2021 when she files her business tax return. She is able to deduct the contributions on her 2020 tax return.
Q: How much can my business contribute to a SEP?
A: For 2020, the maximum deductible contribution to a SEP is the lesser of $57,000 or 25% of eligible compensation for each eligible employee. This amount is indexed each year. The maximum deductible contribution for 2021 will be $58,000 or 25% of eligible compensation. The same percentage of pay must be contributed for all eligible employees.
How do I set up a SEP?
Q: What questions must be answered on the IRS Form 5305-SEP?
A: You must answer 5 questions on the IRS Form 5305-SEP:
1. Name of Business
2. Age Limit, if any (Maximum age is 21)
3. Years of Service Required, if any (Maximum service is 3 years)
4. Will the SEP exclude any employees who are Union Employees or Non-Resident Aliens?
5. Will employees be covered with compensation less than $450 (indexed to $600 in 2020) per year?
Sign the form. Give a copy to your accountant and each of your employees. And, of course, keep the original for your records.
Retirement Plan Options
Q: What other retirement plan options does my business have?
A: Your business could also sponsor a Savings Incentive Match Plans for Employees (SIMPLE), a Profit Sharing Plan, 401(k) Plan or Defined Benefit Plan. Each of these types of plans has advantages and disadvantages. We can tailor a plan to best fit your business needs.
Can I set up a 401(k) Plan for last year?
Q: Can I start a 401(k) Plan for my business now and get a deduction for 2020?
A: No. 401(k) Plans require contributions from employee’s deferred compensation. Since all pay checks were issued by December 31, 2020, no deferrals can be deducted from 2021 pay checks for the 2020 tax year. A 401(k) Plan can be started now for the current plan year.