Part one of this series addressed a type of Defined Contribution Plan (DCP) created particularly for individuals and small business owners – IRAs or Individual Retirement Accounts. Now we’ll discuss another Defined Contribution Plan which is probably the most widely known, 401(k) plans.
A 401(k) Plan is a plan set up by an employer which allows employees to defer a portion of their salary, before taxes, to a retirement account. As with IRAs, the funds and interest on the funds, accrue untaxed until distributed upon retirement.
There are some major differences however, some of which are listed below:
- With an IRA all contributions are 100 percent vested, however some 401(k) plans may use a vesting schedule, meaning that employer contributions belong to the employee only after a specified number of years.
- A 401(k) allows greater access to funds by permitting the employee to take loans from the funds which must be paid back.
- In 2009 and 2010, employee contributions are limited to $16,500 annually with an additional $5,000 allowed if participant is over 50, while IRAs are limited to $11,500 with an allowed catch-up contribution of $2,500.
- 401(k) plans may be subject to annual nondiscrimination testing to ensure that the amount of contributions made on behalf of rank-and-file employees is proportional to contributions made on behalf of owners and managers.
- IRAs are easier to set up and operate and do not require filing an annual return.
Our next segment will discuss the different types of 401(k) plans.
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