Investing What Is a 408(k) Plan? By Rebecca Lake Updated on April 30, 2022 Reviewed by Anthony Battle In This Article View All In This Article Definition and Example of a 408(k) Plan How a 408(k) Plan Works 408(k) Plan vs. 401(k) Plan Photo: Betsie Van Der Meer / Getty Images Definition A 408(k) plan is a tax-advantaged retirement plan that's designed for smaller businesses. Self-employed individuals and sole proprietors who have no employees can also use a 408(k) plan to build retirement wealth. Key Takeaways A 408(k) plan is a type of tax-advantaged retirement savings account designed for small businesses, sole proprietors, and self-employed individuals.This type of plan is also referred to as a Simplified Employee Pension or SEP IRA.Traditional IRAs and 408(k) plans follow the same distribution and rollover rules.408(k) plans have some key differences from 401(k)s regarding who can contribute and how those contributions are vested. Definition and Example of 408(k) Plan A 408(k) plan—also known as a Simplified Employee Pension or SEP—is a retirement account that businesses can offer in place of a 401(k). These plans allow small-business owners to contribute money toward their employees' retirement as well as their own retirement savings. Self-employed individuals can also establish a SEP to save money for retirement on their own behalf. A 408(k) follows the same investment, distribution, and rollover rules as traditional individual retirement plans (IRAs). Alternate name: Simplified Employee PensionAcronyms: SEP, SEP IRA For example, let’s say you run a freelance writing business as a sole proprietor. You decide to open a SEP IRA through an online brokerage, which requires completing a simple online form. Once your 408(k) plan is open, you can contribute money up to the IRS annual contribution limits to fund your retirement. Note Unlike 401(k) plans, which allow for elective salary deferrals from employees, 408(k) plans are funded only by the employer. How a 408(k) Plan Works Businesses of any size can establish a Simplified Employee Pension or 408(k), though they may appeal more to smaller businesses for two reasons. First, a 408(k) plan is typically easier to establish than a 401(k) plan. Companies can create one by adopting IRS Form 5305. Second, 408(k) plans can be easier to maintain and administer, as there are no filing requirements for employers, and overhead costs tend to be lower. A 408(k) plan is not the same as a 401(k) in terms of how contributions work and the guidelines for establishing these plans. While a business of any size can set up a 408(k), not all employees can contribute. Employees are eligible if they: Are at least 21 years of ageHave worked for your business in three of the last five yearsReceived at least $650 in compensation from your business (as of tax year 2021) These eligibility requirements apply to all plan participants, including the plan owners. Businesses can exclude employees who are: Covered by a union agreement if retirement benefits were bargained for in good faith by you and the employees' union ORNonresident aliens with no U.S. source of compensation You could also choose to exclude employees who don't meet the above-mentioned requirements for age, years of service, or compensation. Only employers make contributions to a 408(k). For 2022, employers can contribute 25% of the employee's compensation or $61,000—whichever is lesser. If you have employees, you can use the following types of compensation to determine contributions: Wages, tips, and other compensation subject to income tax withholding under section 3401(a) Amounts described in Internal Revenue Code Section 6051(a)(8) Compensation deferred under a 457 plan The maximum compensation limit that can be used for these calculations in tax year 2022 is $305,000. Your net earnings from self-employment are used to determine what you can contribute. Specifically, it's based on earnings from self-employment minus one-half of your self-employment tax and contributions to your SEP IRA. For example, say you're a sole proprietor and for tax year 2021, you had net earnings from self-employment of $150,000. You could have contributed a maximum of $27,881 to a 408(k) plan for tax year 2021. Note There are no catch-up contributions permitted for a 408(k) plan. A 408(k) or SEP IRA follows the withdrawal rules as traditional IRAs do. That means you'll pay ordinary income tax on the money you withdraw. And withdrawals made before age 59 ½ may be subject to a 10% early withdrawal penalty. 408(k) Plan vs. 401(k) Plan A 408(k) plan and a 401(k) plan offer two very different approaches to saving for retirement. Both can offer advantages to employees as well as employers, though there may be some disadvantages to consider, as well. A 408(k) plan may also offer different investment options than a 401(k). Here's a breakdown of how these plans compare side by side. 408(k) Plan 401(k) Plan Funding Employer contributions only Elective salary deferrals; employers may offer matching contributions Contribution Limits (2022) Lesser of 25% of employee compensation or $61,000 $20,500, plus $6,500 in catch-up contributions if you're 50 or older Catch-up Contributions Allowed? No Yes Contributions Tax-Deductible? Yes, for employers Yes, for employers and employees Vesting Employees are 100% vested at all times Employees are vested according to their plan's schedule Rollovers Permitted? Yes Yes Loans Permitted? No Yes, if the plan allows it Taxation Qualified withdrawals are subject to income tax; early withdrawal penalties may apply Qualified withdrawals are subject to income tax; early withdrawal penalties may apply Subject to Required Minimum Distributions (RMDS)? Yes Yes Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. IRS. “SEP Plan FAQs.” Accessed Dec. 10, 2021. Pacific Life. Self-Employed Retirement Plan Maximum Contribution Calculator.” Accessed Dec. 10, 2021. IRS. “Retirement Topics—Exceptions to Tax on Early Distributions.” Accessed Dec. 10, 2021. IRS. Simplified Employee Pension Plan (SEP).” Accessed Dec. 10, 2021. Related Articles Investing How Does a SEP Roth IRA Work? Is There a SIMPLE Roth IRA? What Is a Keogh Plan? Do I Need Earned Income for Roth IRA Contributions? What to Do After Maxing Out Your Roth IRA Contributions How the Self-Employed Can Save for Retirement With a SEP-IRA Tax Planning with Simplified Employee Pension (SEP) Plans How To Roll Over a 401(k) to a Roth IRA Can I Roll After-Tax 401(k) Funds to a Roth IRA? SEP-IRA Contribution Limits and Deadlines What Are Nonelective Contributions? Rollover IRA vs. Roth IRA: What's the Difference? When Did Roth IRAs Start? What Are the Risks of a Roth IRA? SEP IRAs for Self-Employed and Small Business Owners Newsletter Sign Up