In its traditional form, a 401(k) plan is a Profit Sharing plan that also allows employees to deposit a portion of their pay into the plan in the form of salary deferrals. These deferrals are deposited on a pre-tax basis, and income taxes are paid only when the monies are withdrawn from the plan. 401(k) plans are attractive to younger employees and serve as an effective recruiting tool. In a deferral-only 401(k) plan, the maximum annual contribution is $19,500 ($26,000 if the participant is age 50 or older by plan year end).
In addition to Employer Profit Sharing contributions, 401(k) plans may also allow for an employer match on employee salary deferrals. When this is done the plan offers not only employee pre-tax contributions but also employer tax-deductible contributions. In a 401(k) plan with employer contributions, the maximum total annual contribution an individual participant may receive is $57,000 ($63,500 if the participant is age 50 or older by plan year end).
Who is a traditional 401(k) plan right for?
401(k) plans are extremely flexible and efficient retirement plans. They have favorable applications for a wide spectrum of businesses. A 401(k) plans is appropriate for:
- Businesses seeking to provide a cost-effective employee benefit and recruitment tool.
- Businesses that want employees to share in the cost of funding their retirement savings.
Traditional 401(k) plans are generally not favorable to “highly compensated employees” (For the 2020 plan year, an employee who earns more than $125,000 in 2019 is an HCE. For the 2021 plan year, an employee who earns more than $130,000 in 2020 is an HCE.). If this is an important consideration, then your company may be best suited for a Safe Harbor 401(k) or a “DASH” 401(k).