Defined Contribution Plan

401(k) Plans

401 (k) Plan

Under a 401(k) plan, an employee can voluntarily elect to make a pre-tax deferral through payroll deduction. The amount of elective deferral is limited by statute. The maximum limit on elective deferral is $18,500 (for 2018). Employees who are age 50 and older can make "catch up" contributions. The maximum "catch up" contribution is $6,000 (for 2018). These limits are adjusted each year to reflect changes in the cost-of-living index.

401(k) plans allow employer to match some portion of the employee’s deferral amount to encourage greater participation. For example, the employer will make a 25% match on the first 4% deferred by the employee. 

401(k) plans are subject to nondiscrimination requirements. To comply with these requirements, employers must perform annual tests known as Average Deferral Percentage (ADP) test and Average Contribution Percentage (ACP) test. Passing these tests are required in order to confirm that the plan does not discriminate in favor of “highly compensated employees”.

Safe Harbor 401 (k) Plan

There are safe harbor designs that can be used to avoid the ADP and ACP tests. Plans can be designed to satisfy "401(k) Safe Harbor" requirements. Under these plans, the employer makes a non-elective contribution of 3% of each employee’s compensation. This contribution is required even if the employee does not elect to defer. The contribution is 100% vested and is not subject to any additional eligibility requirement. All employees that are eligible to defer must receive the contribution.

ROTH 401 (k) Plan

Salary deferral contributions can be made to a Roth 401(k) on a post-tax basis. The difference between a Roth 401(k) and a traditional 401(k) is that the Roth 401(k) is funded with after-tax contributions while the traditional 401(k) is funded with pre-tax contributions. However, distributions under a Roth 401(k) are tax-free while distributions under a traditional 401(k) are taxable as ordinary income.