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401(k) Plans

What is a 401(k) Plan?

A 401(k) Plan is a salary deferral arrangement where employees elect to defer a portion of their compensation for retirement. The employee does not pay tax on the deferral until the money is taken out of the plan, usually at retirement. Often, these plans offer a matching option, where the employer elects to match a portion of the employee’s deferral with a company contribution. The match may be fixed or discretionary.

A 401(k) plan may include a profit sharing component, which is based on an allocation formula and the employee’s compensation. Unlike a match the employee does not need to be deferring any of their salary to receive the profit sharing, they just need to meet the eligibility and entry requirements for the plan. Profit Sharing is also discretionary and can change from year to year.

Safe Harbor 401(k) Plan

A Safe Harbor Plan is a 401(k) Plan with a Safe Harbor contribution feature. The Safe Harbor feature requires the employer to make; a mandatory contribution. The employer may make:

1. Dollar for dollar match on the first 3% of deferral, then 50 cents on the dollar on the next 2%.
2. Dollar for dollar enhanced match on the first 4% deferral.
3. Non-elective contribution of 3% of the employee’s wages, which goes to all eligible employees, deferring or not.

All contribution types are fully vested. Safe Harbor Plans are exempt from ADP and ACP testing, which allows owners and officers to defer the maximum deferral limit with no ramifications, regardless of what the other employees choose to defer. In some cases a safe harbor plan may also avoid top heavy testing. A safe-harbor notice must be provided each year between 30 and 90 days prior to the beginning of the Plan Year.

One Person 401(k) Plan

A One Person 401(k) plan can be funded up to 25% of income, in addition to the 401(k) deferral amount (up to $49,000, or $54,500 if age 50 or older); the same limits as a group 401(k) plan. A One Person 401(k) can include an owner and spouse (if the spouse receives a W-2 income). No employees (other than a spouse) can be a participant in a One Person 401(k) plan.

There are various limits, both individual and corporate, that need to be watched in a retirement plan environment. While these limits are independent, each has an affect on the others.

• Deferral Limit: The lesser of 100% of gross compensation or $16,500 (2010).
• Age 50 catch up contribution: Persons age 50 or older may make an additional $5,500 deferral in 2010. This contribution is not included in the $49,000 415 limit.
• 415 Limit: Personal Limit – The lesser of 100% of gross compensation or $49,000. (This limit includes any deferral, match, profit sharing and forfeitures the individual receives)
• Compensation Limit: $245,000