IRAs & 401Ks

Choose from a wide variety of account options

Traditional IRA

Best for: People who expect to be in a lower tax bracket after retirement or don't qualify for a Roth IRA due to their income level.

• The classic way to save for retirement
• Has tax advantages now, with potential tax-deductible contributions to your account
• Your investment savings are tax-deferred — it's not taxed until you withdraw the money

ROTH IRA

Best for: People who expect to be either in the same tax bracket or a higher one after retirement — and who meet the lower income limits of a Roth IRA.

• An IRA with more flexibility when you withdraw the money
• Has tax advantages at retirement
• Your contributions aren't tax-deductible, but qualified withdrawals are tax free

SEP IRA

Best for: People who are self-employed and want the ability to save for themselves or business with very few or no employees.

• Retirement plan for small businesses and the self-employed
• Employers contributions are tax-deductible

SIMPLE IRA

Best for: Employers with a work force of 100 or less who want employees to fund the bulk of their own retirement.

• Retirement plan for people who are self-employed and small businesses with 100 employees or fewer
• All contributions are pre-tax

401(k) Plans

401(k) plans can be a powerful tool in promoting financial security in retirement. They are a valuable option for businesses considering a retirement plan, providing benefits to employees and their employers.
Employers start a 401(k) plan for a host of reasons:

• A well-designed 401(k) plan can help attract and keep talented employees.
• It allows participants to decide how much to contribute to their accounts.
• Employers are entitled to a tax deduction for contributions to employees’ accounts.
• A 401(k) plan benefits a mix of rank-and-file employees and owners/managers.
• The money contributed may grow through investments in stocks, bonds, mutual funds, money market funds, savings accounts, and other investment vehicles.
• Contributions and earnings generally are not taxed by the Federal Government or by most State governments until they are distributed.
• A 401(k) plan may allow participants to take their benefits with them when they leave the company, easing administrative responsibilities.

This booklet highlights some of a 401(k) plan’s advantages, some of your options and responsibilities as an employer operating a 401(k) plan, and the differences among the types of 401(k) plans. For more information, a list of resources for you and for 401(k) plan participants is included at the end of

Establishing A 401(k) Plan
When you establish a 401(k) plan, you must take certain basic actions. One of your first decisions will be whether to set up the plan yourself or to consult a professional or financial institution — such as a bank, mutual fund provider, or insurance company — to help with establishing and maintaining the plan. In addition, there are four initial steps for setting up a 401(k) plan:

• Adopt a written plan document,
• Arrange a trust fund for the plan’s assets,
• Develop a recordkeeping system, and
• Provide plan information to employees eligible to participate.

Adopt a written plan document — Plans begin with a written document that serves as the foundation for day-to-day plan operations. If you have hired someone to help with your plan, that person likely will provide the document. If not, consider obtaining assistance from a financial institution or retirement plan professional. In either case, you will be bound by the terms of the plan document.
Once you have decided on a 401(k) plan, you will need to choose the type of 401(k) plan that is best for you — a traditional 401(k) plan, a safe harbor 401(k) plan, or an automatic enrollment 401(k) plan. In all of these plans, participants can make contributions through salary deductions.

A traditional 401(k) plan offers the maximum flexibility among the three types of plans. Employers have discretion over whether to make contributions on behalf of all participants, to match employees’ deferrals, or to do both. These contributions can be subject to a vesting schedule (which provides that an employee’s right to employer contributions becomes nonforfeitable only after a period of time). Annual testing ensures that benefits for rank-and-file employees are proportional to benefits for owners/managers.

There are several kinds of 401(k) plans that aren't subject to the annual benefits testing required with traditional 401(k) plans. These are known as safe harbor 401(k) plans and, in exchange for avoiding the annual testing, employees in these plans must receive a certain level of employer contributions. Under the most popular safe harbor 401(k) plan (discussed in this publication), mandatory employer contributions must be fully vested when made.

An automatic enrollment 401(k) plan allows you to automatically enroll employees and place deductions from their salaries in certain default investments, unless the employee elects otherwise. This is an effective way for many employers to increase participation in their 401(k) plans.
The traditional, safe harbor, and automatic enrollment plans are for employers of any size.

This booklet addresses traditional and safe harbor 401(k) plans. For more information on automatic enrollment 401(k) plans, see Automatic Enrollment 401(k) Plans for Small Businesses.

Once you have decided on the type of plan for your company, you will have flexibility in choosing some of the plan’s features — such as which employees can contribute to the plan and how much. Other features written into the plan are required by law. For instance, the plan document must describe how certain key functions are carried out, such as how contributions are deposited in the plan.

Arrange a trust fund for the plan’s assets — A plan’s assets must be held in trust to assure that assets are used solely to benefit the participants and their beneficiaries. The trust must have at least one trustee to handle contributions, plan investments, and distributions. Since the financial integrity of the plan depends on the trustee, selecting a trustee is one of the most important decisions you will make in establishing a 401(k) plan. If you set up your plan through insurance contracts, the contracts do not need to be held in trust.

Develop a recordkeeping system — An accurate recordkeeping system will track and properly attribute contributions, earnings and losses, plan investments, expenses, and benefit distributions. If a contract administrator or financial institution assists in managing the plan, that entity typically will help keep the required records. In addition, a recordkeeping system will help you, your plan administrator, or financial provider prepare the plan’s annual return/report that must be filed with the Federal Government.

Provide plan information to employees eligible to participate — You must notify employees who are eligible to participate in the plan about certain benefits, rights, and features. In addition, a summary plan description (SPD) must be provided to all participants. The SPD is the primary vehicle to inform participants and beneficiaries about the plan and how it operates. The SPD typically is created with the plan document. (For more information on the required contents of the SPD, see Disclosing Plan Information to Participants below.)
You also may want to provide your employees with information that discusses the advantages of your 401(k) plan. The benefits to employees — such as pretax contributions to a 401(k) plan (or tax-free distributions in the case of Roth contributions), employer contributions (if you choose to make them), and compounded tax-deferred earnings — help highlight the advantages of participating in the plan.

Operating A 401(k) Plan
Once you have established a 401(k) plan, you assume certain responsibilities in operating the plan. If you hired someone to help in setting up your plan, that arrangement also may have included help in operating the plan. If not, another important decision will be whether to manage the plan yourself or to hire a professional or financial institution — such as a bank, mutual fund provider, or insurance company — to take care of some or most aspects of operating the plan.
Elements of operating 401(k) plans include the following:

• Participation
• Contributions
• Vesting
• Nondiscrimination
• Investing 401(k) plan monies
• Fiduciary responsibilities
• Disclosing plan information to participants
• Reporting to government agencies
• Distributing plan benefits

Participation - Typically, a plan includes a mix of rank-and-file employees and owners/managers. However, some employees may be excluded from a 401(k) plan if they:

• Have not attained age 21;
• Have not completed a year of service; or
• Are covered by a collective bargaining agreement that does not provide for participation in the plan, if retirement benefits were the subject of good faith bargaining.

Employees cannot be excluded from a plan merely because they are older workers.

Contributions - In all 401(k) plans, participants can make contributions through salary deductions. You can decide on your business’s contribution to participants’ accounts in the plan.

Traditional 401(k) Plan - If you decide to contribute to your 401(k) plan, you have further options. You can contribute a percentage of each employee’s compensation for allocation to the employee’s account (called a nonelective contribution), or you can match the amount your employees decide to contribute, or you can do both (within the limits of the current tax law).

For example, you may decide to add a percentage — say, 50 percent — to an employee’s contribution, which results in a 50-cent increase for every dollar the employee sets aside. Using a matching contribution formula will provide additional employer contributions only to employees who make deferrals to the 401(k) plan. If you choose to make nonelective contributions, the employer makes a contribution for each eligible participant, whether or not the participant decides to make a salary deferral to his or her 401(k) plan account.
Under a traditional 401(k) plan, you have the flexibility of changing the amount of employer contributions each year, according to business conditions.

Safe Harbor 401(k) Plan - Under a safe harbor plan, you can match each eligible employee’s contribution, dollar for dollar, up to 3 percent of the employee’s compensation, and 50 cents on the dollar for the employee’s contribution that exceeds 3 percent, but not 5 percent, of the employee’s compensation. Alternatively, you can make a nonelective contribution equal to 3 percent of compensation to each eligible employee’s account. Each year you must make either the matching contributions or the nonelective contributions. The plan document will specify which contributions will be made and this information must be provided to employees before the beginning of each year.

Roth Contributions - 401(k) plans may permit employees to make after-tax contributions through salary deduction. These designated Roth contributions, as well as gains and losses, are accounted for separately from pretax contributions. However, designated Roth contributions are treated the same as pretax contributions for many key aspects of plan operations, such as contribution limits.
As a result of a recent law change, employers may amend their 401(k) plans to allow participants to transfer certain amounts in the plan to their designated Roth account in the plan.

Contribution Limits - Employer and employee contributions and forfeitures (nonvested employer contributions of terminated participants) are subject to a per-employee overall annual limitation. This limit is the lesser of:

• 100 percent of the employee’s compensation, or
• $49,000 for 2010 and 2011.

In addition, the amount employees can contribute (elective deferrals) under any 401(k) plan is limited to $16,500 for 2010 and 2011.
All 401(k) plans can allow catch-up contributions of $5,500 for 2010 and 2011 for employees age 50 and over.
Vesting - Employee salary deferrals are immediately 100 percent vested — that is, the money that an employee has contributed to the plan cannot be forfeited. When an employee leaves employment, he or she is entitled to those deferrals, plus any investment gains (or minus losses) on his or her deferrals.

In safe harbor 401(k) plans, all required employer contributions are always 100 percent vested. In traditional 401(k) plans, you can design your plan so that employer contributions become vested over time, according to a vesting schedule.
Nondiscrimination - To preserve the tax benefits of a 401(k) plan, the plan must provide substantive benefits for rank-and-file employees, not just business owners and managers. These requirements are called nondiscrimination rules and compare both plan participation and contributions of rank-and-file employees to owners/managers.

Traditional 401(k) plans are subject to annual testing to assure that the amount of contributions made on behalf of rank-and-file employees is proportional to contributions made on behalf of owners and managers. In most cases, safe harbor 401(k) plans are not subject to annual nondiscrimination testing.

Investing 401(k) Plan Monies - After you decide on the type of 401(k) plan, you can consider the variety of investment options. One decision you will need to make in designing a plan is whether to permit your employees to direct the investment of their accounts or to manage the monies on their behalf. If you choose the former, you also need to decide what investment options to make available to the participants. Depending on the plan design you choose, you may want to hire someone either to determine the investment options to make available or to manage the plan’s investments. Continually monitoring the investment options ensures that your selections remain in the best interests of your plan and its participants.

Fiduciary Responsibilities - Many of the actions needed to operate a 401(k) plan involve fiduciary decisions. This is true whether or not you hire someone to manage the plan for you or do some or all of the plan management yourself. Controlling the assets of the plan or using discretion in administering and managing the plan makes you and the entity you hire a plan fiduciary to the extent of that discretion or control. Hiring someone to perform fiduciary functions is itself a fiduciary act. Thus, fiduciary status is based on the functions performed for the plan, not a title.

Some decisions with respect to a plan are business decisions, rather than fiduciary decisions. For instance, the decisions to establish a plan, to include certain features in a plan, to amend a plan, and to terminate a plan are business decisions. When making these decisions, you are acting on behalf of your business, not the plan, and therefore, you would not be a fiduciary. However, when you take steps to implement these decisions, you (or those you hire) are acting on behalf of the plan and thus, in making decisions, may be acting as fiduciaries.
Basic Responsibilities - Those persons or entities that are fiduciaries are in a position of trust with respect to the participants and beneficiaries in the plan. The fiduciary’s responsibilities include:

• Acting solely in the interest of the participants and their beneficiaries;
• Acting for the exclusive purpose of providing benefits to workers participating in the plan and their beneficiaries, and defraying reasonable expenses of the plan;
• Carrying out duties with the care, skill, prudence, and diligence of a prudent person familiar with such matters;
• Following the plan documents; and
• Diversifying plan investments.

These are the responsibilities that fiduciaries need to keep in mind as they carry out their duties. The responsibility to be prudent covers a wide range of functions needed to operate a plan. And, since all these functions must be carried out in the same manner as a prudent person would, it may be in your best interest to consult experts in various fields, such as investments and accounting.

In addition, for some functions, there are specific rules that help guide the fiduciary. For example, the deductions from employees’ paychecks for contribution to the plan must be deposited with the plan as soon as reasonably possible, but no later than the 15th business day of the month following the payday. If you can reasonably make the deposits in a shorter time frame, you need to make the deposits at that time.
For plans with fewer than 100 participants, salary reduction contributions deposited with the plan no later than the 7th business day following withholding by the employer will be considered contributed in compliance with the law.

For all contributions, employee and employer (if any), the plan must designate a fiduciary, typically the trustee, to make sure that contributions due to the plan are transmitted. If the plan and other documents are silent or ambiguous, the trustee generally has this responsibility. As part of following the plan documents in operating your plan, the plan document will need to be updated from time to time for changes in the law.