A 401(k) plan is a type of profit-sharing plan that enables employees to set aside a portion of their salary for retirement savings. These plans often include matching contributions from employers, which can significantly boost employee participation. One of the key advantages of a 401(k) is the option to make pre-tax contributions, which can lower the taxable income for both the employer and the employee.
Suitability
401(k) plans can be established by a variety of business structures, including sole proprietorships, partnerships, corporations (both S and C), and non-profit organizations. However, government entities are not eligible to set up 401(k) plans.
Contributions
A 401(k) plan can receive multiple types of contributions:
Employer Contributions: These contributions can be either non-elective (not dependent on how much an employee contributes) or matching (applying a formula based on how much each employee contributes).
Employee Contributions: Employees can contribute on a pre-tax or Roth basis through salary deferrals.
After-Tax Contributions: If permitted by the plan, employees can also make after-tax contributions.
Each type of contribution is subject to specific limits:
Salary Deferrals: Employees can defer up to 100% of their compensation or the applicable annual limit, whichever is lower. The combined total of pre-tax and Roth deferrals must not exceed this limit.
Employer Contributions: The total contributions from the employer generally must not surpass 25% of the total compensation for all eligible employees.
Overall Contributions: The maximum combined contributions for each individual, including all types of contributions, must not exceed 100% of the individual's annual compensation or $70,000 ($77,500 for those aged 50 or older, $81,250 for those aged 60 to 63) in 2025, whichever is less.
Compensation Cap: For calculating employer contributions, the maximum compensation considered is capped at $350,000 for 2025.
Salary deferral limits are as follows:
|
| 401(k) Catch-up for Age 50 and Up | Added Catch-up Limit for ages 60-63 |
2023 | $22,500 | $7,500 | n/a - effective in 2025 |
2024 | $23,000 | $7,500 | n/a - effective in 2025 |
2025 | $23,500 | $7,500 | $3,750.00 |
Maximum Eligibility Requirements
Employers have the option to set criteria for employees to be eligible to participate in a 401(k) plan, though it’s not mandatory. The strictest criteria that can be imposed are:
Age Requirement: Employees must be at least 21 years old.
Service Requirement: Employees must have completed one year of service, which equates to 1,000 hours worked in the previous year.
This maximum is adjusted starting in 2024 for long-term, part-time employees, defined as those who work at least 500 hours in two or more consecutive years (three years in 2024).
Exclusions
Employees covered by a collective bargaining agreement, where retirement benefits were negotiated in good faith, can be excluded.
Nonresident alien employees who do not receive wages, salaries, or compensation from U.S. sources can also be excluded.
Long-term, part-time employees aged 21 or older who work between 500 and 999 hours for two consecutive years must be allowed to participate. However, they can be excluded from nondiscrimination tests and top-heavy rules.
Vesting
Employees are fully vested immediately in their salary deferrals.
Discretionary contributions made by the employer may follow a vesting schedule as chosen by the employer, meaning these contributions can become fully owned by the employee over a set period.
Deadlines
Plan Establishment Deadline: Employers must establish a new 401(k) plan by their business tax filing deadline, including any extensions. Note that employee contributions may only be made prospectively from the date the plan document is executed.
Salary Deferral Deposits: Employee salary deferrals must be deposited into the plan as soon as administratively possible, and no later than the 15th business day of the month following the month of deferral. Note that in most cases, ‘as soon as administratively feasible’ is considered well before the ‘no later than’ date.
For smaller plans with fewer than 100 participants, the Department of Labor (DOL) provides a safe harbor rule: if deferrals are deposited within 7 business days of receipt or withholding, they are considered timely.
Employer Contributions: Employers have until their business tax filing deadline, including extensions, to fund all employer contributions.
Additional Information
401(k) plans can be complex and often require professional administrative services for tasks like preparing the Form 5500 and conducting required testing and other compliance activities.