Employers offer 401(k) plans for many reasons, including attracting and retaining talent. These plans help an employee accumulate a retirement nest egg on a tax-advantaged basis. If you’re thinking about participating in a plan at work, here are some of the features.
Under a 401(k) plan, you have the option of setting aside a number of your wages in a retirement plan. By setting cash aside in a 401(k), you’ll reduce your gross income, and defer tax until you cash out. It will either be distributed from the plan or from an IRA or other plan that you roll your proceeds into after leaving your job.
Your wage will be reduced by the amount of pre-tax contributions that you make — saving you current income taxes. But the amounts will still be subject to Social Security and Medicare taxes. If your employer’s plan allows, you may instead make all, or some, contributions on an after-tax basis (these are Roth 401(k) contributions). With Roth 401(k) contributions, the amounts will be subject to current income taxation, but if you leave these funds in the plan for a required time, distributions (including earnings) will be tax-free.
Your elective contributions — either pre-tax or after-tax — are subject to annual IRS limits. For 2021, the maximum amount permitted is $19,500. When you reach age 50, if your employer’s plan allows, you can make additional “catch-up” contributions. For 2021, that additional amount is $6,500. So if you’re 50 or older, the total that you can contribute to all 401(k) plans in 2021 is $26,000. Total employer contributions, including your elective deferrals (but no catch-up contributions), can’t exceed 100% of compensation for 2021, or $58,000, whichever is less.
Typically, you’ll be permitted to invest the number of your contributions (and any employer matching or other contributions) among available investment options that your employer has selected. Periodically review your plan investment performance to determine that each investment remains appropriate for your retirement planning goals and your risk specifications.
Another important aspect of these plans is the limitation on distributions while you’re working. First, amounts in the plan attributable to elective contributions aren’t available to you before one of the following events: retirement (or other separation from service), disability, reaching age 59½, hardship, or plan termination. And eligibility rules for a hardship withdrawal are very stringent. A hardship distribution must be necessary to satisfy an immediate and heavy financial need.
As an alternative to taking a hardship or other plan withdrawal while employed, your employer’s 401(k) plan may allow you to receive a plan loan, which you pay back to your account, with interest. Any distribution that you do take can be rolled into another employer’s plan (if that plan permits) or to an IRA. This allows you to continue the deferral of tax on the amount rolled over. Taxable distributions are generally subject to 20% federal tax withholding, if not rolled over.
Employers may opt to match contributions up to a certain amount. If your employer matches contributions, you should make sure to contribute enough to receive the full match. Otherwise, you’ll miss out on free money!
These are just the basics of 401(k) plans for employees. For more information, contact your employer. Of course, we can answer any tax questions you may have.
Interested in participating in a 401(k) plan offered by your employer? Under a 401(k), you have the option of setting aside a certain amount of your wages in a retirement plan. By making this election, you’ll reduce your gross income, and defer tax on the amount until the cash (adjusted by earnings) is distributed to you. It will either be distributed from the plan or IRA that you roll your proceeds into after leaving your job. Your elective contributions are subject to annual IRS limits. For 2021, the maximum amount permitted is $19,500. If you’re age 50 or older, you can make additional “catch-up” contributions. For 2021, that extra amount is $6,500.
As mitigation measures related to COVID-19 ease, it will be interesting to see which practices and regulatory changes were taken in response to the pandemic remain in place long-term. One of them might be relief from a sometimes inconvenient requirement related to the administration of 401(k) plans.
In IRS extends administrative relief for 401(k) plans, the IRS recently announced a 12-month extension of its temporary relief from the requirement that certain signatures be witnessed “in the physical presence” of a 401(k) plan representative or notary public.
The original relief, which appeared in IRS Notice 2020-42, was provided primarily to facilitate plan loans and distributions under the CARES Act. However, the relief could be used during 2020 for any signature that, under regulations, had to be witnessed in the physical presence of a plan representative or notary public. This included required spousal consents. The relief was subsequently extended through June 30, 2021, under IRS Notice 2021-03.
Under the notices, signatures witnessed remotely by a plan representative satisfy the physical presence requirement if the electronic system uses live audio-video technology and meets four requirements established under the original relief:
Signatures witnessed by a notary public satisfy the physical presence requirement if the electronic system for remote notarization uses live audio-video technology and is consistent with state law requirements for a notary public.
As mentioned, IRS Notice 2021-40 further extends the relief — subject to the same conditions — through June 30, 2022. The notice also requests comments regarding whether permanent modifications should be made to the physical presence requirement. Comments are specifically requested regarding:
Comments should be submitted by September 30, 2021.
Going forward, the need for a signature may often relate to spousal consents. If your business recently established a 401(k), the plan may be designed to limit the need for spousal consents.
However, plans that offer annuity forms of distribution are still subject to the spousal consent rules. And other 401(k) plans must require spousal consent if a married participant wants to name a non-spouse as the primary beneficiary. Feel free to contact our firm for more information on the latest IRS guidance addressing employee benefits.
In Notice 2021-40, the IRS recently announced a 12-month extension (through June 30, 2022) of its temporary relief from the requirement that certain signatures must be witnessed “in the physical presence” of a 401(k) plan representative or notary public; instead, audio-video technology can be used. The relief was provided primarily to facilitate plan loans and distributions under the CARES Act, but it applies to any signature that is required to be witnessed in the physical presence of a plan representative or notary public. This includes spousal consents. Notice 2021-40 also requests comments regarding whether permanent modifications should be made. Contact us for more information.