Salary reduction plan

Also found in: Dictionary.

Salary reduction plan

A plan allowing employees to contribute pre-tax income to a tax-deferred retirement plan.

Salary Reduction Plan

An employer-sponsored plan whereby the employee does not receive a check for his/her entire salary. Rather, the employer puts a portion of the salary into the plan directly; the contribution is automatically invested for the employee's retirement. This sort of plan may make this reduction either before or after the employee's taxes. This determines whether or not the withdrawals after retirement are taxable. See also: IRA, 401(k).

salary reduction plan

A retirement plan that permits an employee to set aside a portion of salary in a tax-deferred investment account selected by the employer. Contributions made to the account and income earned by the contributions are sheltered from taxes until the funds are withdrawn. Also called 401(k) plan.

Case Study Salary reduction plans offer substantial tax benefits, yet at the same time they can place employee contributions at considerable risk depending on what type of investments are used to fund the plans. Especially risky are plans that invest all or most of the contributions in the employer's common stock. Consider the example of energy conglomerate Enron Corporation, whose stock tumbled nearly 99% to 60¢ per share in the 12 months ending November 2001. At of the end of 2000 approximately half of Enron's $2.1 billion 401(k) plan was invested in Enron common stock. Enron's policy was to match employee contributions at 50¢ on the dollar, for up to 6% of an employee's salary. Like many major corporations, Enron made its contributions to the firm's plan in company stock. Employees were permitted to select alternative investments, but many chose to use Enron shares to fund their contributions. As Enron shares plummeted many employees of the company saw virtually the entire value of their individual 401(k) plans evaporate at the same time as they faced the possibility of losing their jobs in a company that filed for bankruptcy.

Salary reduction plan.

A salary reduction plan is a type of employer-sponsored retirement savings plan. Typical examples are traditional 401(k)s, 403(b)s, 457s, and SIMPLE IRAs.

A salary reduction plan allows you, as an employee, to contribute some of your current income to a retirement account in your name and to accumulate tax-deferred earnings on those contributions. In most plans, you contribute pretax income, which reduces your current income tax, and you pay tax at withdrawal at your regular rate.

Your employer may match some of or all your contribution according to a formula that applies on an equal basis to all participating employees. All salary reduction plans have an annual contribution cap that's set by Congress and allow annual catch-up contributions for participants 50 and older.

With Roth 401(k) and similar plans, you contribute after-tax income but qualify for tax-free withdrawals if you are older than 59 1/2 and your account has been open at least five years.

Mentioned in ?

References in periodicals archive ?

Many salary reduction plans go beyond the premium payment plan format and permit employees to reduce their salaries through a flexible spending account (FSA).

Pretax plans for small businesses. (Employee Benefit Plans)

By making these reimbursements tax-free, what the salary reduction plan does is to convert all of these expenditures that you would normally incur into "deductible" expenses--whether or not they normally would be allowed as a deduction.

Cutting Your Salary Can Make You Money

The cost of these non-taxable benefits are specifically excluded from an employee's gross income through this salary reduction plan.

Cafeteria plans save employer and employee costs

New Mexico argues that the meaning of the term is dear and that a salary reduction agreement excludes arrangements such as New Mexico's in which the employees' participation in the salary reduction plan is mandated by state statute.

RECENT CASES AND RULINGS

* IRS guidance dealt with the proper sourcing of compensation performed partly within and outside the U.S., employment tax treatment of payments for employment termination, taxation of transferred partnership interests and salary reduction plans.

Current developments (Part I: this two-part article provides an overview of current developments in employee benefits, including executive compensation, welfare benefits and retirement plan requirements. Part I focuses primarily on executive compensation.)

Beyond those exceptions, section 409A applies broadly to salary reduction plans, supplemental employee retirement plans (SERPs), parachute payments, phantom stock plans, severance plans, insurance commissions, discounted stock options, certain SARs, non-excluded fringe benefits, etc.

The law of unintended consequences: international implications of section 409A

To avoid immediate taxation, deferred compensation plans--which include salary reduction plans, 401(k) wrap-arounds and supplemental executive retirement plans--executed after Dec.

Tax season: everything you need to navigate through the busy season

The bill would increase the dollar limit on annual elective deferrals under Section 401(k) plans, Section 403(b) annuities, and salary reduction plans in $1,000 annual increments until the limits reach $15,000 in 2005.

House Approves Pension Bill

Other provisions would relieve top-heavy rules, streamline the reporting rules and the deduction rules for small businesses in order to afford them the opportunity to offer more generous defined contribution plans, eliminate the IRS user fees for small business plans and provide incentives for employers to establish salary reduction plans that will automatically enroll employees.

Questions to the tax desk

* Increase and index the current catch-up contributions, and allow catch-up contributions under all salary reduction plans for anyone age 50 and older.

Public Retirement Plans

* Catch-up provisions for salary reduction plans (e.g., 401(k) and TSA) at age 50, which increase from $1,000 in 2002 to $5,000 in 2006 and beyond.

New pension planning options. (Employee Benefit Plans)

"Employees who aren't contributing to salary reduction plans should ask themselves, 'Can I afford not to?'" says Charles Ross, an Atlanta-based certified financial planner.