A 401k plan is a qualified, defined contribution plan that allows employees to set aside tax-deferred income for retirement purposes. In some cases, employers will match employee contributions and/or make discretionary contributions that are not based on employee contributions.
Is a 401k plan only available through an employer?
Yes. Most large companies sponsor 401k plans. Many small and mid-sized companies also sponsor 401k plans to compete in the war for talent with larger firms.
Different variations of the 401k exist to suit the size and needs of different companies.
Why is it called a 401k?
This retirement saving option is made possible through Section 401k of the Internal Revenue Code, hence the term 401k.
If I sponsor a 401k plan, am I a plan fiduciary?
Yes. As an employer sponsoring a retirement plan, you are always deemed a plan fiduciary under ERISA guidelines.
What is a plan fiduciary?
A plan fiduciary is someone who:
- Assumes discretionary authority or control over the administration of the plan
- Exercises any authority or control over the management or disposition of plan assets
- Renders investment advice to the plan or its participants for a fee or other compensation, whether direct or indirect
What is ERISA?
ERISA is an acronym for the Employee Retirement Income Security Act, a federal law enacted in 1974 that established legal guidelines for the administration of and investment practices within defined benefit and defined contribution plans.
What does it mean to say a 401k plan is qualified?
As a qualified plan, a 401k plan allows pre-tax contributions (which are qualified contributions). These contributions are tax-deductible. Additionally, the plan is an IRS-approved trust that must be in writing and strictly adhere to IRS and Labor Department reporting and disclosure guidelines. It also cannot discriminate.
What does it mean to say a 401k plan cannot discriminate?
The actual deferral percentage (ADP) of highly compensated employees may not exceed the ADP of non-highly compensated employees by specified amounts. The plan must pass an ADP test. A similar test, an actual contribution percentage (ACP) test is required for plans that provide an employer match.
What is an employer match?
It is an employer contribution to promote participation in the plan. An employee may receive 25 cents or 50 cents — sometimes even $1 — for every pre-tax dollar he or she contributes up to a certain percentage, often 3%, of annual pay. Vesting requirements may apply to receive a match.
What does it mean to say a 401k is a defined contribution plan?
The employee makes contributions to the plan via payroll deduction. Employer matching contributions are made every payday, too. Unlike a defined benefit plan, often known as a “pension plan,” the employer is not required to provide a specific amount at retirement.
What does it mean to say contributions are tax-deferred?
Taxes are not due on contributions — or any investment earnings — until money is withdrawn. This helps speed the growth of the employee’s account. Taxes will be due upon withdrawal, and withdrawals before age 59½ may be subject to an additional IRS tax penalty.
How much may an employee contribute?
Contribution limits are adjusted from year to year.
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