March 01, 2012
Good benefits continue to help attract and retain good employees, and retirement savings plans are one of the biggest carrots you can offer. Perhaps your dealership is considering setting up a new plan or changing its plan. Let’s review one of the most popular retirement savings plans — the 401(k) — to help you get started.
The most popular type of retirement savings plan is the 401(k), which most small and midsize businesses find affordable. Under this defined contribution plan, employees contribute a portion of their pretax salary into the plan each pay period. For 2012, employee contributions are limited to $17,000 — $22,500 for taxpayers age 50 and up.
The 401(k) plan gives the employee a variety of investment options — such as mutual funds, bond funds and money market funds. Employees typically make their investment choices online and generally can change their choices at any time. Plan earnings aren’t guaranteed, and earnings (or losses) will vary depending on the performance of the investments selected. Employees can opt out of contributing to the plan at any time.
Perhaps the biggest advantage of a traditional 401(k) plan is tax-deferred compounding; participants usually aren’t taxed until they withdraw plan assets. Usually this is at retirement. With a few exceptions, employees must begin to withdraw “required minimum distributions” starting after age 70½ or face a penalty equal to 50% of the amount they should have withdrawn.
An employee can withdraw money from a 401(k) before retirement if there is a qualifying event, such as disability or termination of employment. The employee will typically owe not only tax but, if under age 59½, also a 10% early withdrawal penalty on such a distribution. The employee can avoid taxes and, if applicable, penalties, by rolling the distribution into another qualified retirement plan or a traditional IRA.
Your plan also might allow distributions for certain hardship situations. Again, the employee will typically owe tax and, if under age 59½, a 10% early withdrawal penalty. Also, he or she will be unable to make deferral contributions to the plan for six months. Another option is to allow participants to take loans from their plans. This avoids taxes and penalties, but the participant must pay back the loan amount plus interest within a five-year period.
Your dealership will have the option to match the employees’ contributions, and you can deduct any matching contributions you make to the plan just as you would ordinary compensation. Providing contributions can strengthen the 401(k) plan as a recruiting and retention tool.
Making contributions also might allow you to avoid strict discrimination testing requirements that otherwise apply to 401(k) plans. By agreeing to make certain annual contributions to employee accounts, you can create a “safe-harbor” plan, which doesn’t require potentially burdensome testing. Such a plan also ensures that certain “highly compensated” employees will be allowed to make the maximum contributions.
Finally, qualified dealerships can claim tax credits of up to $500 a year for the plan’s first three years to cover start-up and maintenance costs. The credit equals 50% of the cost to set up and administer the plan up to a maximum of $500 per year.
According to the IRS, about half of Americans don’t have retirement plans at work. If you choose to offer employees this valuable benefit, it can help you attract and retain the best employees. But before implementing a plan, consult your tax advisor about how the plan will affect the financial side of your business.
If you offer a traditional 401(k), you also can offer employees a Roth 401(k). Roth 401(k) contributions are made with after-tax dollars.
The benefit? Participants can generally withdraw funds from the plan tax-free after age 59½. Distributions of contributions are always tax-free, but distributions on earnings are tax-free only for qualifying events. Additionally, the participant must have held the 401(k) account for five years or more.
Roth 401(k)s often appeal to younger employees who expect to be in a higher tax bracket when they withdraw money from the plan. These employees will typically see a higher after-tax investment return than they would with a traditional 401(k).
Roth 401(k)s may also appeal to higher-income employees who may be prohibited from contributing to an individual Roth IRA because of income-based limits. The limits don’t apply to Roth 401(k) contributions.
In addition, although Roth 401(k)s are subject to required minimum distribution (RMD) rules, participants can roll the plan assets into a Roth IRA upon a qualifying event. And Roth IRAs aren’t subject to RMD rules.
Employer matching and profit sharing contributions can’t be made to Roth 401(k) accounts, however. And, with some limited exceptions, employees can’t roll over a traditional 401(k) into a Roth IRA 401(k).