Definition and Example of a 408(k) Plan
How a 408(k) Plan Works
408(k) Plan vs. 401(k) Plan
Definition and Example of a 408(k) Plan
A 408(k) plan is a tax-advantaged retirement plan designed for small businesses. Self-employed individuals and sole proprietors without employees can also utilize a 408(k) plan to build retirement wealth.
How a 408(k) Plan Works
Businesses of all sizes can establish a simple retirement plan for their employees, or a 408(k) plan, although it may be more appealing to small businesses for two reasons. First, a 408(k) plan is typically easier to set up than a 401(k) plan. Companies can create a 408(k) plan by adopting IRS Form 5305. Second, 408(k) plans can be easier to maintain and manage, as there are no reporting requirements for employers, and operational costs are lower.
408(k) Plan vs. 401(k) Plan
Both 408(k) and 401(k) plans offer two completely different approaches to retirement savings. Both can provide benefits for employees and employers, although there may also be some drawbacks to consider. A 408(k) plan may offer different investment options compared to a 401(k) plan.
Here is a breakdown of how these two plans compare side by side:
Funding
Funded by employers only
Contribution Limits (2022)
Less than 25% of employee compensation or $61,000
Are Additional Contributions Allowed?
No
Are Contributions Tax-Deferred?
Yes, for both employers and employees
Vesting
Employees are 100% vested at all times
Are Transfers Allowed?
Yes
Are Loans Allowed?
No
Taxes
Qualified withdrawals are subject to income tax; early withdrawals before age 59½ may be subject to a 10% early withdrawal penalty
Subject to Required Minimum Distributions (RMDs)?
Yes
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