401(k)
A 401 (k) plan allows employees to defer income from their pay and contribute that amount to a separate account for their retirement benefit. 401(k) plans are an option in Profit Sharing Plans.
The employee always “owns” 100% of the amount contributed from their pay. In other words, an employee is fully vested in his or her own contribution. Employers may match employee contributions on a dollar or percentage basis. Vesting schedules for employer matching contributions permit the employee to "own" a certain percentage of the match over a period of time. The matching contribution is generally considered part of a profit sharing contribution for plan purposes.
Employees may borrow 50% of their vested plan balance in a defined contribution plan, to a maximum of $50,000. This loan is generally repaid in substantially equal installments at least over 5 years. If the loan is secured by property, the property then becomes collateral for the plan and you may be entitled to a thirty year term to repay the debt. The interest rate must be at least the imputed interest rate as applicable to meet IRS guidelines.
Generally speaking, for the year 2007, there is a cap of 55% of total compensation on the combined sum that employers and employees can contribute annually to 401(k) plans on a tax-favored basis. This applies to compensation as high as $220,000.
From 2002 until 2012, employee deferrals won't be counted toward the current cap of 25% of compensation, or $15,000. This means that it is possible for owner-only businesses to make a large employer contribution and then also make the maximum $15,000 per person deferral.
For sole proprietorships, the percentage-of-pay limits apply to compensation after plan contributions are subtracted and after one-half of self-employment tax is deducted. This means that the current cap of 25% of compensation is actually 20% of earnings before those contributions.
The one-person 401(k) offers the biggest potential benefit for one-person businesses earning between $50,000 and $160,000. If you are a business owner and a corporate employee is already participating in another 401 (k) plan, you must take into consideration the fact that your combined deferrals to both plans can't exceed the $15,000 per person cap. 401(k) contributions are considered separately for percentage calculations in Profit Sharing Plans. This means that the employee contribution is not counted against the employer contribution 25% limitation. The employee deferral amount is, however, included as part of the $44,000 maximum contribution amount. This is a distinct benefit for owner-only plans in which income does not reach the dollar limitations ($160,000) because it allows the owner to make the highest contribution possible.
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