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If you're a business owner, putting money back into your business is not the only way to invest for the future. Regularly placing funds in an investment account is prudent planning. You should consider a qualified account, such as a 401(k) plan, which provides tax advantages on the amounts invested and on the gains generated in the account.
The basis of the 401(k) plan is the profit-sharing plan. A profit-sharing plan, in its simplest form, gives you and other employees the opportunity to share company profits in any given year. The contributions are discretionary and invested according to various allocation formulas. Under Subsection 401(k) of the Internal Revenue Code, you also can contribute your own money to the profit-sharing plan on a pre-tax basis.
In order to protect employees from employer discrimination, several tests were developed to ensure the company does not unfairly allocate funds to highly compensated personnel at the expense of rank-and-file employees. However, those requirements may limit the amount you can contribute to the plan for your own retirement. Here is an explanation of those tests:
* Actual deferral percentage (ADP). This annual test limits average deferrals of highly paid employees to the greater of 1.25 times the average for rank-and-file employees or 2 percent plus the average contribution for rank-and-file employees (up to two times the average).
* Actual contribution percentage (ACP). This annual test uses the same formula as the ADP test but looks at employer matches and after-tax employee contributions.
* Top heavy. A plan is deemed to be "top heavy" if more than 60 percent of its assets are in the accounts of key employees. For any year that a plan is top heavy, the employer is required to contribute 4 percent of salary for each rank-and-file employee.
In addition to these …