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A 401(k) plan is a qualified retirement savings plan that includes a feature allowing an employee to elect to have the employer contribute a portion of the employee’s wages to an individual retirement account. 401k contributions are generally not subject to federal income tax withholding at the time of deferral, and they are not reported as taxable income on the employee’s individual income tax return.
A traditional 401(k) plan allows eligible employees to make pre-tax elective deferrals through payroll deductions. In order to ensure that the plan satisfies these requirements, the employer must perform annual tests, known as the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests.
To pass the ADP test, the average contribution rate of HCEs for the year cannot exceed the greater of:
The non-HCE average can be based on current or prior year contribution rates.
The ACP test uses the same methodology as the ADP to test matching and voluntary after-tax contributions for nondiscrimination.
A safe harbor 401(k) plan is similar to a traditional 401(k) plan, but, among other things, it must provide for employer contributions that are fully vested when made. In order to satisfy the content requirement, the notice must describe the safe harbor method in use, how eligible employees make elections, any other plans involved, etc. Income Tax Regulations section 1.401(k)-3(d)(2) (PDF), contains information on satisfying the content requirement using electronic media and referencing the plan’s Summary Plan Description.
Both the traditional and safe harbor plans are for employers of any size and can be combined with other retirement plans.
The SIMPLE 401(k) plan was created so that small businesses could have an effective, cost-efficient way to offer retirement benefits to their employees. This type of 401(k) plan is available to employers with 100 or fewer employees who received at least $5,000 in compensation from the employer for the preceding calendar year. For more information on traditional, safe harbor and SIMPLE 401(k) plans, see Publication 4222, 401(k) Plans for Small Businesses PDF.
A 401(k) plan cannot require, as a condition of participation, that an employee
complete more than 1 year of service.
A 401(k) plan can have an automatic enrollment feature. This feature permits the employer to automatically reduce the employee’s wages by a fixed percentage or amount and contribute that amount to the 401(k) plan unless the employee has affirmatively chosen not to have his or her wages reduced or has chosen to have his or her wages reduced by a different percentage.
The law, under IRC section 402(g), limits the amount that a participant can defer on a pre-tax basis each year. See the 401(k) Plan Contribution Limits.
If the plan document permits, the employer can make matching contributions for an employee who contributes elective deferrals to the 401(k) plan.
Also, If the plan document permits, the employer can make additional contributions (other than matching contributions) for participants, including participants who choose not to contribute elective deferrals to the 401(k) plan. If the 401(k) plan is top-heavy, the employer may be required to make minimum contributions on behalf of certain employees.
All employees must be fully (100%) vested in their elective deferrals. A plan may
require completion of a specific number of years of service for vesting in other
employer or matching contributions.
The employer reports elective deferrals on the participant’s Form W-2, Wage and Tax Statement.
Form W-2, Wage & Tax Statement
Publication 525
W-2 Instructions
