Types of 401(k) Plans | Which 401(k) Plan Is Right for Your Business?

What Are the Different Types of 401(k) Plans to Choose from?

As an employer, you can offer small business retirement options, like 401(k) plans, to your employees. But when it comes to 401(k) options, it isn’t just a one and done type of deal. There are a few different types of 401(k) plans to choose from.

401(k) Overview

Let’s brush up on what 401(k) is, shall we? A 401(k) plan is an employer-sponsored retirement plan where employees can choose how much they contribute. Based on the options you offer in your plan, employees can contribute a certain amount each paycheck to their retirement plan. Some 401(k) plan contributions are pre-tax while others are post-tax.

Offering a 401(k) plan can help recruit and retain employees, incentivize employees to work harder, and lower your tax burden. With a 401(k) plan, you can deduct your employer contribution amounts on your federal income tax return.

Some plans require you to contribute to the 401(k) as the employer while others don’t. Many employers will opt to contribute up to a certain amount, too. For example, you may decide to match 50% of the employee’s 401(k) contribution up to 8%. This means if an employee contributes 8% each paycheck, you contribute 4%. But if the employee increases their contribution to 9%, you still only contribute 4%.

Types of 401(k) plans

So, what options do you have when it comes to 401(k) plans? Here are the different types of 401(k) plans you can have at your business:

  • Traditional 401(k) plans
  • Safe harbor 401(k) plans
  • SIMPLE 401(k) plans
  • Solo 401(k) plans
  • Roth 401(k) plans

Most retirement plans can be combined with other plans. For example, if you have a traditional 401(k) plan, you can also have a Roth 401(k) plan.

If you contribute to a 401(k) plan as an employer, set rules for contributions, such as a waiting period. For example, an employee might need to work for you for six months before you begin contributing.

Starting a 401(k) plan for a small business is different for each option in terms of flexibility, contribution limits, and business size. Compare each 401(k) plan before making a decision on which route to go for your company.

types of 401(k) plans businesses can offer to employees

Traditional 401(k) plans

Many businesses choose a traditional 401(k) plan as the retirement benefit to offer employees. Under a traditional plan, employees contribute a portion of their wages before taxes (aka pre-tax) to their 401(k).

A pre-tax 401(k) deduction reduces an employee’s taxable wages, meaning they will likely owe less federal income, Social Security, and Medicare taxes.

With this plan, some employers match a portion of the employee’s 401(k) contributions (e.g., 50% up to 6%). The income taxes on the employer and employee contributions are tax-deferred.

Here’s what you need to know about traditional 401(k) plans:

  • Who can offer a traditional plan:
    • A private or public employer of any size can offer a traditional plan to employees
  • Contribution requirements:
    • You can either contribute for all participants (even if they don’t contribute), make matching contributions based on an employee’s elective deferral, or both
    • Contributions can be subject to a vesting schedule where your employer contributions to an employee’s plan become nonforfeitable after a certain amount of time (e.g., three years)
  • Contribution limit:
    • Employees can only defer up to a certain amount, which typically changes each year
    • Employees can defer up to $19,500 to their 401(k) retirement plan in 2021
    • Employees who are 50 or older can contribute an additional catch-up contribution that also changes annually. The additional contribution limit for 2021 is $6,500
    • The amount of employer and employee contributions combined cannot be larger than the annual limit. The limit must be the lesser of 100% of the employee’s compensation or $58,000 for 2021
  • Plan requirements:
    • To set up a traditional 401(k) plan, create a plan document that follows IRS rules, establish a trust for the plan’s assets, maintain good 401(k) records (e.g., contributions and values), and provide information to participating employees
  • Filing requirements:
    • File Form 5500, Annual Returns/Reports of Employee Benefit Plan each year to report employee benefit plan information

If you choose a traditional 401(k) plan, you must conduct an annual nondiscrimination test to ensure the contributions don’t just benefit highly compensated employees. The test compares the average salary deferrals of highly compensated employees to non-highly compensated employees. You must perform and pass the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests to keep a traditional 401(k) plan. Check the IRS’s website for more information on the ADP and ACP tests.

Safe harbor 401(k) plans

A safe harbor 401(k) plan is a special type of retirement plan that automatically passes the nondiscrimination test. This means that you don’t have to pass an ADP and ACP test each year like you do with a traditional 401(k) plan.

Safe harbor 401(k) plans are popular with small businesses because employers can avoid the time and money it takes to pass nondiscrimination tests each year. But there’s one caveat: you are required to contribute to an employee’s safe harbor retirement plan.

With a safe harbor plan, you must contribute to an employee’s 401(k), regardless of their title, compensation, or length of service.

Get more facts about safe harbor 401(k) plans below:

  • Who can offer a safe harbor plan:
    • Businesses of any size can offer a safe harbor 401(k) plan
  • Contribution requirements:
    • You must make either an eligible matching (basic or enhanced) or nonelective contribution
    • A basic match is a 100% match on the first 3% of deferred compensation, plus an additional 50% for each contribution that is over 3% but under 5%
    • An enhanced match is a 100% match on the first 4% of deferred compensation
    • A nonelective contribution is 3% (or more) of compensation, regardless of employee deferrals
    • Employer contributions are required to be fully vested, and your employees are guaranteed your contributions to their safe harbor 401(k) plan
  • Contribution limit:
    • The contribution limit for a safe harbor 401(k) plan is the same as a traditional 401(k) plan. Employees can defer up to $19,500 (2021) and the additional contribution limit for 2021 is $6,500
    • The amount of employer and employee contributions combined cannot be larger than the annual limit. The limit must be the lesser of 100% of the employee’s compensation or $58,000 for 2021
  • Plan requirements:
    • Employers must give each eligible employee a written notice that lists their rights and obligations. Provide a written notice to eligible employees before each plan year
  • Filing requirements:
    • Like traditional 401(k) plans, file Form 5500 each year if you have a safe harbor plan

SIMPLE 401(k) plans

A SIMPLE 401(k) plan is ideal for small business owners or self-employed professionals with 100 or fewer employees. This type of plan is a simplified version of a traditional 401(k) plan.

A SIMPLE 401(k) plan combines the features of a traditional plan with the simplicity of a SIMPLE IRA. And with a SIMPLE 401(k), you don’t need to perform nondiscrimination tests.

Under a SIMPLE 401(k) plan, your contributions are nonforfeitable as soon as you contribute them. However, employees who participate in a SIMPLE 401(k) plan cannot receive contributions and accruals with any other employer-sponsored retirement plan.

Check out more details of the SIMPLE 401(k) plan:

  • Who can offer a SIMPLE 401(k) plan:
    • Small businesses with 100 or fewer employees
    • If your business exceeds the 100 employee limit, there is a 2-year grace period before you need to change your 401(k) plan. To qualify for the grace period, you must have had a SIMPLE 401(k) plan for at least one year and no longer qualify due to your business growing
  • Contribution requirements:
    • You must contribute to your employees’ plans
    • Both the employee and employer contribution are pre-tax
    • As an employer, you must make either a matching contribution of up to 3% of each employee’s pay or a nonelective contribution of 2% of each eligible employee’s pay
  • Contribution limit:
    • Employees can only contribute up to $13,500 in 2021 under a SIMPLE 401(k) plan
    • Employees who are 50 years or older can contribute up to an additional $3,000 for 2021
  • Plan requirements:
    • To establish a SIMPLE 401(k) plan, create a written plan, get it approved by the IRS, and explain the written plan to your employees
  • Filing requirements:
    • File Form 5500 if you have a SIMPLE 401(k) plan at your business

Solo 401(k) plans

A solo 401(k) plan only has one participant. It is a traditional 401(k) plan designed specifically for a business owner or self-employed individual with no employees apart from their spouse or business partners. This type of plan is also called an individual 401(k), self-employed 401(k), or solo-k.

The plan allows the employer to make contributions as both an employer and an employee. This allows business owners to maximize retirement contributions and business deductions. All contributions you make are tax-deductible.

Learn more about solo 401(k) plans below:

  • Who can offer a solo 401(k) plan:
    • Sole proprietors, self-employed individuals, small business owners, or individuals with no employees except for a spouse or partners
  • Contribution requirements:
    • You can contribute as both the employee and the employer. You do not have to contribute as the “employer”
  • Contribution limit:
    • In a solo 401(k), you’re both the employee and the employer
    • As the employee, you can contribute up to $19,500 or 100% of compensation (whichever is less) for 2021 AND make an additional profit-sharing contribution of up to 25% of your compensation
    • If you are over 50 years old, an additional $6,500 catch-up contribution (total contribution of $26,000) is allowed for 2021
    • Your total contribution (excluding catch-up contributions) cannot exceed $58,000 in 2021
  • Plan requirements:
    • As long as you have an Employer Identification Number (EIN), you can open a solo 401(k) account as long as you meet eligibility requirements
  • Filing requirements:
    • Solo 401(k) participants must file Form 5500-EZ, Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan annually

Roth 401(k) plans

A Roth 401(k) plan has similarities to a traditional 401(k) and a Roth IRA. But with a Roth 401(k), you deal with post-tax deductions instead of pre-tax. Withhold taxes from an employee’s gross pay before you defer their wages to the 401(k) plan.

When an employee retires, withdrawals from traditional 401(k) accounts are taxed at ordinary income rates. But with a Roth 401(k), withdrawals are generally tax-free.

If you decide to offer a Roth 401(k) option, you must also offer a traditional 401(k) plan where the contributions are taken out before taxes. Like the traditional 401(k) plan, you also need to perform annual nondiscrimination testing on Roth 401(k) plans. A Roth 401(k) plan must be a separate account from the other 401(k) plans you offer.

Here’s everything you need to know about establishing a Roth 401(k) plan for your employees:

  • Who can offer a Roth 401(k) plan:
    • Businesses of any size can offer a Roth 401(k) plan
  • Contribution requirements:
    • Employers are not required to contribute to employees’ Roth 401(k) plans. However, you can choose to match your employees’ contributions to a Roth 401(k) plan
  • Contribution limit:
    • Employees can contribute a maximum of $19,500 to their Roth 401(k) plan in 2021
    • Employees age 50 or older can contribute an additional $6,500 in 2021
  • Plan requirements:
    • You must offer a traditional 401(k) plan in addition to a Roth plan. Create a plan document, establish a trust for the plan’s assets, and provide information to participating employees
  • Filing requirements:
    • File Form 5500 annually
RequirementsEmployee Contribution Limit (2021)Do Employers Need to Contribute?
Traditional 401(k) PlanNoneEmployees under 50: $19,500

Employees 50 or older: $26,000
No
Safe Harbor 401(k) PlanNoneEmployees under 50: $19,500

Employees 50 or older: $26,000
Yes
SIMPLE 401(k) PlanMust have 100 or fewer employeesEmployees under 50: $13,500

Employees 50 or older: $16,500
Yes
Solo 401(k) PlanMust have no employees (except for a spouse or partners)Under 50: $19,500

50 or older: $26,000
No
Roth 401(k) PlanNoneEmployees under 50: $19,500

Employees 50 or older: $26,000
No

Other types of retirement plans

401(k) retirement plans aren’t the only options for business owners to offer employees. You might be able to offer the following:

  • Individual Retirement Arrangement (IRA)
  • Roth IRA
  • 403(b) plan
  • SIMPLE IRA plan
  • Simplified Employee Pension (SEP) plan
  • Salary Reduction Simplified Employee Pension (SARSEP) plan
  • Profit-sharing plan (PSP)
  • Employee stock ownership plan (ESOP)

To learn more about your retirement plan options for your business, check out the IRS’s website for more information.

Need a simple way to deduct your employees’ 401(k) contributions? Patriot’s online payroll software makes it a breeze to track pre-tax and post-tax deductions for 401(k) plans and more. Start your free trial today!

This article has been updated from its original publication date of May 21, 2012.

This is not intended as legal advice; for more information, please click here.

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