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Friday, November 26, 2021

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408(k) Plan vs. 401(k) Plan: What’s the Difference?

Each 408(okay) and 401(okay) discuss with sections of the Internal Revenue Code that define employer-sponsored retirement plans. Each present pointers for plans that enable workers to put aside a portion of their paychecks earlier than taxes are taken out to be invested in a particular account meant for retirement financial savings.

That is the place these two alphanumeric codes diverge. Whereas 401(okay)s have change into synonymous with a broadly out there retirement financial savings car, 408(k)s set the rules for what’s extra generally often called the simplified employee pension or SEP IRA.

Key Takeaways

  • 408(okay)s and 401(okay)s are each retirement financial savings plans that employers can provide to workers.
  • 401(okay)s are the commonest sort of plan.
  • A SEP is simply out there to corporations with 25 workers or fewer.
  • Not like a 401(okay), worker contributions should not permitted as a part of the SEP contribution limits.


Based on the IRS, “SEPs have been licensed by Congress in 1978 to supply employers with an easier, easier method of offering retirement advantages for themselves and their workers.”

Part 408(okay)(1) of the Inside Income Code defines a SEP as a person retirement account or particular person retirement annuity with respect to sure participation, contribution, discrimination, and withdrawal necessities being met.”

Employers might contribute to SEP IRAs even when the worker can also be the employer. Employers might make tax-deductible contributions on behalf of eligible employees—together with the enterprise proprietor—to their SEP IRAs. The employer is allowed a tax deduction for plan contributions that don’t exceed the statutory restrict.


A 401(k) is the commonest sort of retirement financial savings account supplied. It’s a certified, employer-sponsored financial savings plan. Employers providing a 401(okay) plan might make matching or non-elective contributions to the plan on behalf of eligible workers and can also add a profit-sharing characteristic to the plan. Earnings in a 401(okay) plan accrue on a tax-deferred foundation.

401(okay) plans are barely extra advanced than 408(okay)s, as they typically comprise various funding choices chosen by the employer. With a SEP IRA, workers select their very own investments.

Key Variations

Basically, what differentiates the 408(okay) SEP IRA from the 401(okay) is that it is solely available to companies with 25 or fewer employees. Listed here are another distinguishing options.

  • On the whole, solely employers can contribute to a SEP IRA. Not like a 401(okay), worker contributions should not permitted as a part of SEP contribution limits. 
  • There are contribution limits for 408(okay)s. Employers can contribute as a lot as 25% of an worker’s wage, however not more than $58,000 for 2021 ($61,000 for 2022). No catch-up contributions are allowed, as SEP IRAs are funded solely with employer contributions.
  • Some SEP IRAs allow separate, private IRA contributions. If your organization’s SEP IRA plan permits it, workers could make their very own IRA contributions to the identical account, as much as the IRA limits ($6,000 for 2021 and 2022—plus a further $1,000 for these age 50 or older).
  • 408(okay) minimal earnings for eligibility. The minimal compensation threshold is $650 in 2021 and 2022.
  • SEP IRA most allowable compensation. Regardless of how a lot an worker earns, the annual compensation restrict that may be thought of in figuring out contributions to a SEP IRA is $290,000 in 2021 ($305,000 for 2022).
  • For each, contributions should not taxed. As with a 401(okay), employer contributions to your part 408(okay) plans are not taxed. 
  • Who can have a 408(okay)? SEP IRAs can be found for workers of corporations with 25 workers or much less; or those that are self-employed and would usually not have entry to a retirement plan.
  • SEP IRA contributions might be tax-deductible. Self-employed individuals with a SEP IRA can deduct the price of a specific amount of non-public contributions to their retirement funds from their revenue.
  • Employer contributions underneath a SEP IRA should be equal. Which means every eligible worker should get the identical share of their wage contributed to the plan.
  • Contribution deadlines observe IRA deadlines. For instance, 2021 contributions to a SEP IRA could also be made till April 15, 2022, or till October with a submitting extension. With a 401(okay), the deadline is the calendar yr (i.e. Dec. 31).
  • Staff, not employers, handle a SEP account. Total, 401(okay) plans are a bit extra advanced than SEPs, with many funding choices arrange by the employer, together with mutual funds that comprise shares, bonds, and commodities. With a SEP IRA, the employer doesn’t arrange funding choices. As an alternative, the worker manages the SEP IRA on their personal, selecting their very own investments. Employers basically put cash (not actual property, which is forbidden) into particular person worker individual retirement accounts (IRAs). This protects the employer from paying administration prices as they might with a 401(okay).
  • Each have a penalty for early withdrawal. Each forms of accounts are inaccessible and not using a penalty till the account holder reaches the certified age of 59½.

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