Wage-earners of a firm that sponsors a Salary Reduction Plan (SRP) have the option of contributing to a qualified trust untaxed dollars that earn tax-free income until the time of withdrawal. At withdrawal, principal and interest are taxed as ordinary income. An SRP is obviously a close cousin to an Individual Retirement Account (IRA), but there are several important differences between the two.
First, a participant in an SRP may contribute up to 15 per cent of his annual earned income, whereas an individual’s annual contribution to an IRA is limited to $2,000. Second, SRP contributions currently are not subject to FICA (Social Security) taxes; thus a smaller percentage of the SRP contribution (relative to the IRA contribution) comes out of the participant’s own pocket. Third, in the event of a qualified hardship, participants may make early withdrawals from an SRP without paying any penalty; early withdrawals from an IRA are, of course, subject to a 10 per cent penalty tax.
Because of these advantages, an SRP offers a higher total return than an IRA in many cases. Whereas anyone who earns income may participate in an IRA, however, participation in an SRP is contingent upon an employer’s adoption of a plan. Unfortunately, many companies have been reluctant to adopt SRPs because of the absence of complete Treasury regulations for such plans.