A 401(k) plan is a retirement plan that meets certain participation requirements of IRC Section 401(k). To make contributions an employee can agree to a salary reduction or to defer a bonus, and the employer can also make discretionary contributions. Employer contributions, if any, are tax-deductible to the employer, are not currently taxable to the employee, and any earnings accumulate income tax-deferred.
The maximum annual participant contribution limit for 2010 is $16,500; for those ages 50 and older an additional “catch-up” contribution of $5,500 can be made. Employers may deduct contributions of up to 25% of covered payroll (maximum eligible per participant is $245,000). Plan investments must be diversified and prudent. Generally, participants direct the investment of their own deferrals and may also direct the investment of the employer contributions. Participant contributions must be always 100% vested. Employer contributions are usually subject to a vesting schedule, so should the participant leave the company before they are 100% vested, a percentage of that portion of the account is forfeited. Any employee who is at least 21 years old and with 1000 hours of service within one year, subject to some exclusions, must be permitted to participate.
Among the advantages to the employer:
-
Employers are not required to make discretionary contributions
-
Contributions are tax deductible
-
Employer can direct employer investments
-
Employer matching contribution is a popular employee benefit
Among the advantages to the employee:
-
Participant generally has the right to direct their investments
-
Participant deferrals are made with pre-tax dollars
-
Earnings on the account are not currently taxed
-
Employer may make matching contributions of some amount
Among the disadvantages to the employer:
-
Employers may be required to make mandated contributions to satisfy certain requirements
-
Administrative costs are greater than with other types of plans
Among the disadvantages to the employee:
-
No guarantee as to future benefits
-
Investment risks rest on the participant
-
Company may or may not make discretionary contributions
