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February 17, 2009

401(k) Plan

Your Guide

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Definition

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.

Referring Cite

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.

  • 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

Written By

Denise Appleby

Denise is CEO of Appleby Retirement Consulting Inc., a firm that provides IRA resources for financial/ tax/legal professionals. She has over 20 years of experience in the retirement plans field, which includes training and technical consultation.

Denise writes and publishes educational /marketing tools for advisors; available at http://irapublications.com. Denise co-authored several books on IRAs

Denise is a graduate of The John Marshall Law School, where she obtained a Masters of Jurisprudence in Employee Benefits, and has earned 5 professional retirement designations.
She has appeared on numerous media programs, sharing her insights on retirement tax laws.

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