401(k) Plan

What is a 401(k) Plan? Under a 401(k) plan, participating employees elect to decrease their salary by a certain percentage of pay and have that deferred income invested in the plan's trust. This reduces the employee's current taxable income and allows the income to accumulate tax-deferred - that is, the income will not be taxable until the date at which the employee actually receives the funds. In addition, the employer may elect to match all or any portion of the amount deferred by the employee. The matching feature is an additional incentive for an employee to participate in the plan.
Why a 401(k) Plan? Today’s economic constraints and market conditions have caused employers to seek more flexibility and cost-effectiveness from employee benefit plans while still offering their employees a means to accumulate retirement benefits. The 401(k) plan is a logical choice to meet these needs. Under this plan, the employer is able to implement a low-cost plan in which employees can reduce their current taxes while setting aside money for their retirement.
Tax Advantages A 401(k) plan provides participants with a tax-sheltered investment vehicle to save for their retirement. Participants invest pre-tax dollars which accumulate tax-deferred. These deferral amounts lower participant's current taxable income and may move participants to a lower tax bracket. Participants pay taxes on deferrals and any gains when they receive a distribution from the plan. These distributions may qualify for special tax treatment.
Deferral Amounts Participants are always 100% vested in deferred amounts. IRS regulations limit the amount of deductible contributions each participant may make during a calendar year. The most recent indexed amounts can be found here. Deferral amounts do not include employer matching contributions, profit sharing contributions, investment gains, or forfeitures. Participants are categorized into two groups - Highly and Non-highly compensated employees. The deferral rate for the highly paid group of employees is limited by the deferral rate of the non-highly paid group. This is why it is extremely important to encourage participation of the lower paid employees.
Employer Contributions Employer discretionary contributions to the plan are also allowed. Employer contributions can be contributions based on Participant deferral amounts, and/or contributions based on Participant compensation.
Safe Harbor Contributions If this provision is set in place, a minimum employer contributions is required every year. However it allows the Plan to automatically pass non-discrimination testing of deferral and matching contributions.
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