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401(k) Plans

401(k) Plans have become popular retirement savings vehicles for small businesses to attract and retain high quality employees. Many employees now consider a 401(k) Plan to be a part of a "standard" benefits package when considering a new job.

The current 401(k) deferral limit for individuals is $17,500. Employees age 50 and older may defer and additional $5,500 in "catch-up" contributions. Contributions must come from payroll withholding. Employees may not defer more than 100% of their current income (after payroll taxes).

Traditional 401(k) Plan

A Traditional 401(k) plan allows a worker to save for retirement while deferring income taxes on the saved money or earnings until withdrawal. The employee elects to have a portion of his or her compensation paid directly, or "deferred", into his or her 401(k) account.

Employers are not required to offer matching contributions; however, doing so may make it easier to pass the required nondiscrimination testing by encouraging employees to participate.

A special nondiscrimination test applies to 401(k) elective deferrals under a 401(k) Plan. The IRS has concluded that even though all employees of a company may have the right to participate in the Plan; those employees who are classified as Highly-Compensated have a greater opportunity to participant due to their higher levels of income. Each traditional 401(k) Plan is required to comply with the Average Deferral Percentage test annually.

Safe-Harbor 401(k) Plans

The IRS has recognized that the special non-discrimination testing requirements of a traditional 401(k) can be particularly onerous to small businesses. The Safe-Harbor 401(k) plans were developed as an alternative to help companies that have had trouble getting their employees to participate.

Under a Safe-Harbor arrangement, the Average Deferral Percentage testing requirement is waived in lieu of a mandatory company contribution. Safe-harbor contributions must be fully vested at all times.

There are two ways to satisfy the safe-harbor requirement. The first is the Safe-Harbor Non-Elective contribution. This would require the company to make a contribution equal to 3% of compensation to all plan participants. Employees who have met the requirements to enter the plan are eligible to receive this contribution regardless of whether they have elected to participate.

The second option for satisfying the safe-harbor requirement is the Safe-Harbor Match. This would require the company to contribute a match up to 4% of compensation. There are a couple of different match formulas available. The first is a 100% match on the first 4% of compensation an employee contributes into the plan.

The second is a 100% match on the first 3% of compensation an employee contributes into the plan plus a 50% match on the next 2% of compensation an employee contributes.

Employees must contribute to the plan in order to receive a matching contribution.

The Safe-Harbor provision must be adopted before the beginning of the Plan year and a special notice is required to be distributed to all employees.

Below are a few of the Benefits of the Roth 401(k)

Companies may also offer a Roth 401(k) feature as a part of their 401(k) Plan. The Roth 401(k) is similar to the Roth IRA in that after-tax money is being saved and grows tax-free, but, as the name implies, the new account will fall under 401(k) rules.

  • The Roth 401(k) is open to all employees who qualify for the regular 401(k). There are no income limitations for eligibility.
  • The Roth feature may be added to a Traditional 401(k) Plan or a Safe-Harbor 401(k) Plan.
  • Money can be withdrawn tax and penalty free at age 59½ as long as the account has been held for at least 5 years.
  • Roth 401(k) accounts will share the same contribution limits of regular 401(k) plans: $17,500 for 2013, or $23,000 for employees who are age 50 and older.
  • Participants will have the choice of contributing on a pre-tax, post-tax or combination basis. All company contributions will still be made on a pre-tax basis.
  • Participants may rollover Roth 401(k) contributions into a Roth IRA when they retire or leave the company. The Roth 401(k) has the same distribution requirements as the traditional 401(k). Minimum distributions are mandatory beginning at age 70½.