What is a 401(k) Plan?
- Named for the Internal Revenue Code Section 401(k)
- Employees contribute part of their salaries on either a pre-tax (traditional) or post-tax (Roth) basis
- The employer can provide a valuable benefit at comparatively little out-of-pocket cost.
- Flexible features provide ability to adapt plan to company’s financial condition, desired tax deduction and other circumstances.
Pre-Tax Contributions (Traditional 401(k) Plan)
- Employee Contributions (Elective Deferrals) made on a before-tax basis. Contributions are excluded from income for federal (and most state) income tax purposes.
- Elective Deferrals and earnings accumulate tax-deferred. Taxes are paid upon distribution.
Roth 401(k) Contributions
- Roth 401(k) contributions are made with after-tax dollars. Contributions are included as taxable income when contributed.
- Qualified distributions from designated Roth 401(k)s and the related investment earnings are completely free from federal income tax.
- Qualified distributions occur:
- 5 years after the first Roth Contribution and
- after the attainment of age 59 ½ or on account of death or disability
Other Types of Contributions
- Employer Matching Contributions may also be made. This contribution may also be discretionary. Matching Contributions would only be made for those participants who elect to make 401(k) contributions
- Employer Non-Elective Contributions (profit sharing contributions) may also be included as part of the Plan, with the same features as a stand-alone profit sharing plan.
For the Participant:
For elective deferral contributions:
- Amounts contributed are not subject to federal (and most state) income taxes when contributed.
- Earnings on contributions accumulate on a tax-deferred basis.
- Taxes are paid upon distribution, which may result in a lower tax rate being applied
For Roth 401(k) contributions:
- For qualified distributions, investment earnings are free from federal income tax. (Underlying contributions were made on a post tax basis and therefore not taxed again.)
For the Company:
- Deductions for matching or other contributions.
Pension Review Services custom-designs 401(k) plans in order to meet the objectives of the client. Design features include:
- Type of Contributions
- Contribution allocation formulas
- Eligibility requirements
- Vesting schedules
Read about some specific design opportunities for 401k plans in our Case Studies section: “More Bang for Your Pension Buck”.