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Basics of setting up a 401(k)
Dear Small Biz Adviser
I own a small security guard and alarm
service and was wondering how to go about starting a 401(k) for
myself and my wife through my company? Do I have to offer it to
my employees also? I have about 23 part-time employees.
Thanks
Larry
Dear Larry:
With tax season fast approaching, we have
received numerous inquiries about 401(k) plans. So it is best to
begin by reviewing some of the basics:
- The title, 401(k), refers to Paragraph K
in section 401 of the 1978 Tax Reform Act, which became part of
the Tax Code. It was interpreted by a sharp accountant to allow
a new type of investment -- one in which employees could set aside
a portion of their pay and invest it in mutual funds, stocks or
bonds held in a tax-deferred retirement account.
- The employee invests directly into the account
as an automatic deduction for each paycheck.
- The employer has the option, as an employment
incentive, to deposit additional funds from company funds.
- The deduction is taken from gross income
before income tax deductions.
- With emergency exceptions, you cannot withdraw
any of the funds until reaching the age of 59 1/2.
- Unlike Social Security funds, you have the
option to decide how the funds are invested as an interest-earning
instrument.
- There are no income taxes on 401(k) interest
earnings until withdrawn from the account.
- If you change employers before reaching 59
1/2, the funds can be rolled over, without penalty, into an IRA
account or into the new employer's 401(k) plan if it exists.
- The maximum pretax amount you can deposit
into the plan in 2001 is $10,500.
- There is no federally mandated minimum deposit,
but most plans require a minimum to insure administration costs
of the plan are covered.
Larry, there is no requirement for you to offer
a 401(k) plan to your employees. On the other hand, if you do, there
is no need for you to incur any expense. The plan can be set up
so that minimum employee deposits cover administration expenses.
Obviously, they would want to deposit more if it is affordable.
Because your employees are all part-timers, you'll need to weigh
the benefits of making a plan available -- chiefly retention --
against its cost and hassle.
As for you and your wife, if you do not intend
to provide the benefit to your employees, you have alternatives:
- Regular 401(k) plans are designed for for-profit
firms with a significant number of employees. The set-up and administrative
costs are significant, and this may not be best for simply you
and your spouse.
- Simple 401(k) plans are designed for companies
with a maximum of 100 employees. The employer must make a matching
contribution up to 3 percent or non-elective contributions of
2 percent on behalf of employees' compensation which exceeds $5,000.
- The Simple IRA allows you to make contributions
up to $6,500 in 2001, compared to $6,000 in 2000. An alternative
is to contribute up to $6,500 of your compensation for which the
company (if you are incorporated) can make an equal matching amount,
for a grand total of $13,000.
- Simplified Employee Pension IRAs allow a
maximum tax-free, annual contribution of up to $35,000 or 15 percent
or your gross income, whichever is less.
- If you are not incorporated, consider a Keogh
Plan. Maximum contribution can reach $35,000, but you will need
to have the plan substantiated as a formalized document outlining
the contribution process.
Finally, I urge you to further research this
material by speaking to your banker, insurance agent or a pension
fund representative. Online alternatives include:
- 401(k)afe
has an extensive archive of information. You'll love the FAQ
section. It is extensive, informative and easy to navigate.
- Advisers401(k)
shows you how to administer a 401(k) plan in-house.
Do a lot of reading and research, get some face-to-face
feedback and advice and then proceed.
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