This guide provides general information. You should contact your plan administrator for information specific to your plan.
A 401(k) plan is a qualified (i.e., meets the standards set forth in the Internal Revenue Code (IRC) for tax-favored status) profit-sharing, stock bonus, pre-ERISA money purchase pension, or a rural cooperative plan under which an employee can elect to have the employer contribute a portion of the employee’s cash wages to the plan on a pre-tax basis. These deferred wages (elective deferrals) are generally not subject to federal income tax withholding at the time of deferral and they are not reflected as taxable income on your Form 1040, U.S. Individual Income Tax Return.
The amounts deferred under your 401(k) plan are reported on your Form W-2, Wage and Tax Statement. Although elective deferrals are not treated as current income for federal income tax purposes, they are included as wages subject to Social Security (FICA), Medicare, and federal unemployment taxes (FUTA). Refer to Publication 525, Taxable and Nontaxable Income, for more information about elective deferrals. Refer to the Form W-2 Instructions for more information on how amounts should be reported.
401(k) plans are permitted to allow you to designate some or all of your elective deferrals as “Roth elective deferrals” that are generally subject to taxation under the rules applicable to Roth IRAs. The information contained in this guide does not pertain to Roth 401(k)s unless specifically stated.
Two of the advantages of participating in a 401(k) plan are:
Elective deferrals to the plan and investment gains are not subject to federal income taxes until distributed from the plan.
Elective deferrals are always 100% vested.
To qualify for the tax benefits available to qualified plans, a plan must both contain language that meets certain requirements (qualification rules) of the tax law and be operated in accordance with the plan’s provisions. The following is a brief overview of important qualification rules. It is not intended to be all-inclusive.
There are several types of 401(k) plans available to employers - traditional 401(k) plans, safe harbor 401(k) plans and SIMPLE 401(k) plans. Different rules apply to each. It is important that you become familiar with your plan so that you understand the special rules that apply to you. Information about the plan must be provided to eligible employees (i.e., employees eligible to participate in the plan) in the Summary Plan Description. An eligible employee may also submit a request in writing to the plan administrator for a copy of the plan document. The administrator may charge a reasonable fee for the copy.
Traditional 401(k) plan
A traditional 401(k) plan allows eligible employees (i.e., employees eligible to participate in the plan) to make pre-tax elective deferrals through payroll deductions. In addition, in a traditional 401(k) plan, employers have the option of making contributions on behalf of all participants, making matching contributions based on employees’ elective deferrals, or both. These employer contributions can be subject to a vesting schedule which provides that an employee’s right to employer contributions becomes nonforfeitable only after a period of time, or be immediately vested. Rules relating to traditional 401(k) plans require that contributions made under the plan meet specific nondiscrimination requirements. In order to ensure that the plan satisfies these requirements, the employer must perform annual tests, known as the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests, to verify that deferred wages and employer matching contributions do not discriminate in favor of highly compensated employees.
Safe harbor 401(k) plan
A safe harbor 401(k) plan is similar to a traditional 401(k) plan, but, among other things, it must provide for employer contributions that are fully vested when made. These contributions may be employer matching contributions, limited to employees who defer, or employer contributions made on behalf of all eligible employees, regardless of whether they make elective deferrals. The safe harbor 401(k) plan is not subject to the complex annual nondiscrimination tests that apply to traditional 401(k) plans.
Employers sponsoring safe harbor 401(k) plans must satisfy certain employee notice requirements. The notice requirements are satisfied if the employer provides each eligible employee with written notice of the employee's rights and obligations under the plan and the notice satisfies content and timing requirements.
In order to satisfy the content requirement, the notice must describe the safe harbor method used, how eligible employees make elections, any other plans involved, etc.
The timing requirement requires that the employer must provide notice within a reasonable period before each plan year. This requirement is deemed to be satisfied if the notice is provided to each eligible employee at least 30 days and not more than 90 days before the beginning of each plan year. There are special rules for employees who become eligible after the 90th day.
Both the traditional and safe harbor plans are for employers of any size and can be combined with other retirement plans.
SIMPLE 401(k) plan
The SIMPLE 401(k) plan was created so that small businesses could have an effective, cost-efficient way to offer retirement benefits to their employees. A SIMPLE 401(k) plan is not subject to the annual nondiscrimination tests that apply to traditional
For more information on traditional, safe harbor and SIMPLE 401(k) plans, see Publication 4222, 401(k) Plans for Small Businesses.
Restriction on conditions of participation
Any 401(k) plan cannot require, as a condition of participation, that an employee complete more than 1 year of service.
Automatic enrollment in a 401(k) plan
A 401(k) plan can have an automatic enrollment feature. This feature permits the employer to automatically reduce your wages by a fixed percentage or amount and contribute that amount to the 401(k) plan unless you have affirmatively chosen not to have your wages reduced or have chosen to have your wages reduced by a different percentage. These contributions qualify as elective deferrals. This has been an effective way for many employers to increase participation in their 401(k) plans.
Elective deferral limits
The law, under IRC Section 402(g), limits the amount that you can defer on a pre-tax basis each year. See the 401(k) plan contribution limits.
Elective deferrals that exceed the 402(g) dollar limit for a year or are recharacterized as after-tax contributions as part of a correction of the Actual Deferral Percentage (nondiscrimination) test are included in your taxable income.
If the plan document permits, the employer can make matching contributions for an employee who contributes elective deferrals to the 401(k) plan. For example, a 401(k) plan might provide that the employer will contribute 50 cents for each dollar that participating employees choose to defer under the plan. As mentioned earlier, employer matching contributions may be subject to annual tests to determine if specific nondiscrimination requirements are met.
Other employer contributions (profit-sharing)
If the plan document permits, the employer can make additional contributions (other than matching contributions) for participants, including participants who choose not to contribute elective deferrals to the 401(k) plan. If the 401(k) plan is top-heavy, the employer may be required to make minimum contributions on behalf of certain employees. In general, a plan is top-heavy if the account balances of key employees exceed 60% of the account balances of all employees.
Employee compensation limit
No more than $275,000 in 2018 ($270,000 in 2017; $265,000 in 2015 and 2016) of an employee’s compensation can be taken into account when figuring contributions. This limit is indexed for inflation.
Plan investment fees
In some cases, plan participants may be liable for investment fees. You can find out more about these fees by visiting the U.S. Department of Labor - Employee Benefits Security Agency (EBSA) website.
You must be fully (100%) vested in your elective deferrals. A plan may require completion of a specific number of years of service for vesting in other employer or matching contributions. For example, a plan may require that the employee complete 2 years of service for a 20% vested interest in employer contributions and additional years of service for increases in the vested percentage.
General rules apply to distributions from a 401(k) plan.
Review your Summary Plan Description or plan document to learn how to apply for a distribution from your 401(k) plan. Your employer or the plan administrator can assist you with the steps that are necessary for you to receive your distribution.
For more information about the treatment of retirement plan distributions, refer to Publication 575, Pension and Annuity Income.