A 401(k) plan is one that allows employees to contribute a portion of their salary on a pre-tax basis. The employer may make additional contributions to the plan in the form of a matching contribution or non-elective contribution.
401(k) plans are subject to special non-discrimination testing that may limit the amount that highly compensated employees may contribute to a multiple of the average contributed by non-highly compensated employees.
More and more employees perceive 401(k) plans as a valuable benefit which have made them the most popular retirement plans today. Employees can benefit from a 401(k) plan even if the employer makes no contribution. Employees voluntarily elect to make pre-tax contributions through payroll deductions up to an annual maximum of $18,000 (2016 limit).
Employees 50 years of age or older may elect to take advantage of newly enacted “Catch-Up” provisions, and contribute an additional $6,000 (2016 limit) bringing their annual total up to $24,000. This additional contribution is not subject to non-discrimination or employer maximum deduction limitations.
Often the employer will match some portion of the amount deferred by the employee to encourage greater employee participation, i.e., 25% match on the first 4% deferred by the employee. Since a 401(k) plan is a type of profit sharing plan, profit sharing contributions may be made in addition to or instead of matching contributions. Many employers offer employees the opportunity to take hardship withdrawals or borrow from the plan.
Employee and employer matching contributions are subject to a special nondiscrimination test which limits how much the group of employees referred to as a “Highly Compensated Employees” can defer based on the amount deferred by the “Non-Highly Compensated Employees.” The plan may be designed to satisfy “401(k) Safe Harbor” requirements (certain minimum employer contributions and 100% vesting of employer contributions) which can eliminate this nondiscrimination test.