Traditional 401(k) Plans
A 401(k) plan is, for the most part, funded by employees. Employees may elect to have a portion of their compensation deferred into their individual 401(k) account. The employer may match deferral contributions and may also fund a profit sharing contribution with this type of plan.
The IRS deferral limit for 2016 is $18,000 and employees age 50 and older may defer an additional $6,000.
Highlights of a 401(k) Plan:
- A very popular employee benefit at a lower cost to the Employer.
- Non-Discrimination testing must be performed to show that the plan is in compliance for tax purposes.
- Total allocation to participants cannot exceed the lesser of 100% of covered compensation up to $53,000 (indexed) per participant. Currently the maximum compensation used for retirement plan calculations for 2016 is $265,000 (indexed).
- Earnings accumulate tax deferred.
- All employees are 100% vested in their employee deferrals. A vesting schedule is generally attached to employer match and profit sharing contributions.
Safe Harbor 401(k) Plans
There are two types of Safe Harbor designs. The first type is a “Safe Harbor 3% Non-Elective” contribution. This design requires the company to make a 3% contribution to all eligible employees, regardless if the employee is making deferral contributions. The second type is a “Safe Harbor Match” contribution. An employee must be making deferral contributions to receive this Safe Harbor Match. The standard matching formula is a 100% match on the first 3% of an employee’s deferral contributions plus a 50% match on the next 2% of employee deferral contributions.
Highlights of a Safe Harbor 401(k) Plan:
- Allows companies to waive the 401(k) Non-Discrimination testing requirements by making a Safe Harbor mandatory company contribution.
- Employees are 100% vested in the Safe Harbor contribution.
- An annual Safe Harbor notice must be provided to all eligible employees.
- This design must be adopted prior to the beginning of the Plan Year.
Roth 401(k) Plans
A Roth feature can be added to a traditional 401(k) Plan or a Safe Harbor 401(k) plan. The Roth 401(k) Plan has the same rules and limits as a standard 401(k) Plan. However, the employee contributions are after-tax contributions.