Retirement planning is a fairly specialized space within the larger arena of personal finance, so it isn’t surprising that there is a lot of industry lingo that might be unfamiliar. Below are some essential terms defined for your convenience.
Some companies include stock awards or options as part of the compensation package. These typically require an employee to hold the shares for a period of time before transferring or selling is permitted.
This is a plan for small businesses that permits both employees and employers to contribute to retirement accounts. Easy for employers to set up and with no filing requirements, these plans must be the only retirement plan offered to employees.
If you are under age 59 ½ when you withdraw from the account, the IRS may penalize you for up to 10% of the withdrawal amount when you file that year’s taxes.
Amounts contributed to a plan by the employer at the employee’s election and, except to the extent they are designated Roth contributions, are excludable from the employee’s gross income.
The total amount of money an employee may contribute to a retirement fund. In 2022, that limit for people age 49 and younger is $20,500. For those age 50 and older, the limit is $27,000.
A retirement plan that’s typically tax-deferred, like a 401(k) in which employees contribute a fixed amount or a percentage of their paychecks in an account that is intended to fund their retirements. The employer will generally match a part of employee contributions as an added benefit to help keep and attract top talent. These plans place restrictions that control when and how each employee can withdraw from these accounts without penalties.
The word the IRS and the financial industry use to talk about withdrawing money from an employer-sponsored retirement plan or any other tax-deferred retirement plan, like an IRA.
Taking money from your account to help cover expenses during a hardship. The IRS defines eligible 401(k) hardships as “immediate and heavy financial needs.” These needs generally include medical care, tuition, emergency home repairs, funeral costs, and eviction prevention.
Individuals open Roth IRAs directly with an investment firm, so there are no employer contributions. Also, Roth IRAs are funded with post-tax income, so employees don’t pay income taxes when they withdraw the amount they deposited and any accrued interest after they retire. And finally, since participants manage the Roth IRA themselves, their investment choices can be broader than with a pre-tax 401(k).
In a 401(k) plan, employers may contribute to an employee’s retirement account up to a certain amount as defined by a percentage or the IRS maximum.
The Internal Revenue Service requires these tests to ensure that employers are offering fair plans to all employees – not just the company owners, highly-compensated employees, and key individuals. Testing should happen annually at the end of the plan year, but proactive companies have their plan administrator conduct routine audits and conduct mid-year analysis to reduce the risk of failure.
Some employers offer pensions, which typically require the employee to work for the company for a set period of time before they qualify to receive the pension.
The plan administrator can be the employer, a company owner, a committee of key executives or board members, or, most commonly, a third-party partner. They set up and maintain the plan on a day-to-day basis. Ubiquity Retirement + Savings is a plan administrator.
In addition to the owner of the company, the plan sponsor can also be a union, a group of representatives, or a key executive. Often, a plan sponsor is also referred to as a “fiduciary” – a person who takes legal responsibility for making decisions on behalf of plan participants. Fiduciaries agree to avoid conflicts of interest and work to keep fees reasonable. The fiduciary can also be held personally liable for plan losses caused by mismanagement.
The company that creates, manages, and sells the retirement plan an employer selects. Ubiquity Retirement + Savings is a plan provider.
A feature that can be added to a 401(k) plan to help employees save for retirement while allowing for maximum flexibility on how much the plan costs. Employers can decide from year to year whether they want to make contributions to employee plans depending on how much revenue the company earned that year. Even if employees themselves do not wish to take advantage of tax-deferred savings, they can still receive the profit share contribution. Compared to 401(k) matching contribution formulas, employers find a wider range of options with profit-sharing, though there may be limitations based on IRS nondiscrimination test rules.
Also called an RMD, this is the smallest amount you must withdraw from your account each year. You generally must start taking withdrawals from your IRA, SEP IRA, SIMPLE IRA, or retirement plan account when you reach age 72.
Moving funds from one retirement account to another. This is typically performed when an employee starts a new job in order to minimize the number of open accounts the employee owns.
Each year, a 401(k) plan needs to pass nondiscrimination tests (see above) designed to prevent any unfair benefits to the company’s high-earning employees. If the 401(k) fails these tests, the business owner can move to a Safe Harbor 401(k) plan, which allows the plan to bypass these tests in exchange for additional contributions from the business owner. Additionally, with a Safe Harbor 401(k) plan, business owners and any highly compensated employees can maximize their contributions instead of being limited by the amount non-highly compensated employees contribute.
If you’re ready to talk about setting up a retirement plan for your company, contact us today for a free consultation.