A qualified retirement plan established by an employer (business) for its employees. Under a 401(k) plan, eligible employees may defer a portion of their wages/salary to their account under the plan. These deferred amounts are referred to as salary-deferral contributions, and can be made on a pre-tax and/or post-tax basis.
Earnings in a 401(k) account grow on a tax-deferred basis and distributions are treated as ordinary income when distributed from the account.
IRC § 401(k)
Additional Helpful Information
Individuals may defer up to 100% of their compensation up to the dollar limit that is in effect for the year. Individuals who reach age 50 by the end of the year may defer additional amounts referred to as ‘Catch-up’ contributions.
- The dollar limits are available here
These are the limits established under federal law. However, an employer may elect to reduce the percentage of salary that an employee may defer to his/her 401(k) account. For instance, the plan may be designed to limit salary deferrals to 10% of compensation. In such a case, if the individual’s compensation for the year is $70,000, the maximum amount he/she can contribute as salary deferral contributions for the year is $7,000 ($70,000 x 10%). Plans may be designed to allow participants to make after-tax salary deferral contributions.
- A 401(k) plan is usually offered as part of a Profit Sharing Plan, stock bonus plan or pre-ERISA money purchase pension plan but can be offered independently.
- The aggregate/total contributions to a participant’s 401(k) account cannot exceed the annual addition limit that is in effect for the year. The limits are :
Individuals who are at least age 50 by the end of the year may make catch-up contributions in addition to the annual addition limit, if catch-up contributions are permitted under the plan.
Employers may choose to make Matching Contributions to the accounts of employees who make salary deferral contributions.
Nondiscrimination testing must be performed to determine if contributions under the plan are skewed disproportionately in favor of Highly Compensated Employees. If the plan fails the test, corrective action must be taken.
- The employer may need to file Form 5500 returns for the plan each year