A 401(k) plan is a type of profit sharing plan that includes an elective salary deferral provision. The employer typically has the ability to make a matching contribution that is tied to the elective salary deferral, as well as a profit sharing contribution that is allocated to all eligible participants. Plan participants usually have the ability to select their own individual asset allocation from various investment alternatives available to the plan.

Eligibility

Employee eligibility requirements for 401(k) plans are typically one year of service and age 21.

Contributions

The three common 401(k) contribution types are:

• Elective salary deferral. The employee can defer up to $12,000 for 2003. (This is an indexed amount subject to cost of living adjustments and may change each year).
• Employer matching. The employer can make a discretionary contribution based on a percentage of the employee's elective salary deferrals.
• Profit sharing. Can be allocated in any method available to regular profit sharing plans.

An employer's maximum deduction is limited to 25% of the annual compensation paid to eligible employees. In addition, the employer must meet several non-discrimination tests, which may further limit the amounts deferred by certain highly paid employees.

Employees age 50 and older may make a $2,000 catch-up contribution (in 2003), which does not count against their individual maximum annual additions limit of the lesser of $40,000 or 100% of compensation.

Advantages

A 401(k) plan allows both employer and employees to contribute toward retirement while reducing the current tax burden of both. Because employees are actively involved as participants, 401(k) plans typically have a high visibility level in terms of the employee's perception of the benefit being provided by the employer.

Download our Qualified Plan Comparison chart (.PDF format) to compare this product to other Qualified Retirement Plan options.

Don't have Adobe Acrobat Reader? Take a moment to download it.