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Types of 401(k) Plans

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

As an employer, you can choose to offer small business retirement options for your employees. For small businesses, there are different types of retirement plans that vary in terms and conditions. 401(k) plans are employer-sponsored retirement plans where employees can choose how much they contribute. Compare the types of 401(k) plans before deciding what to offer your employees.

Types of 401(k) plans

Offering retirement plans is a great part of an employee’s benefits package. 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. For example, if you have a traditional 401(k) plan, you can also have a Roth 401(k) plan. However, you cannot have a SIMPLE 401(k) and another plan.

If you contribute to a 401(k) plan, set rules for when you begin contributions. For example, an employee might need to work for you for six months or one year before they can receive employer contributions.

Keep in mind that you should avoid late contributions by following all 401(k) deposit rules for employers.

Each one of the 401(k) investment options is different in terms of requirements like flexibility, contribution limits, and business size.

Traditional 401(k) plans

Under a traditional 401(k) plan, employees contribute portions of their wages before taxes to their retirement plans. The pre-tax elective deferral reduces the amount of taxes that are withdrawn.

If you choose a traditional small business 401(k), you must conduct annual nondiscrimination tests to make sure the contributions do not only benefit highly compensated employees. You will need to perform and pass the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests to keep a traditional 401(k) plan. These tests compare salary deferrals of highly compensated employees and non-highly compensated employees.

Here are some of the requirements if you decide to establish a traditional 401(k) plan.

Employee requirements

In order to have a 401(k) plan, you do not need to meet a size requirement. For example, you can have five employees or 500 employees to offer a 401(k) plan.

Contribution requirements

If you decide to set up a traditional 401(k) plan, you can choose to contribute. 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.

With a traditional 401(k) plan, your contributions can be subject to a vesting schedule. With a vesting schedule, your contributions to an employee’s plan become nonforfeitable (funds belong completely to the employee) after a certain period of time. To see a vesting schedule, consult the IRS.

For example, you have an employee who quits after one year at your business. If your vesting schedule listed in your 401(k) plan only gives the employee access to your contributions after three years, they forfeit those funds.

Contribution limit

For a traditional 401(k) plan, employees can only defer up to a certain amount. The limit, set by the IRS, could change each year. In 2017, employees can defer up to $18,000 to their 401(k) retirement plan.

Employees who are 50 and older can contribute an additional catch-up contribution. This limit changes each year, too. For 2017, the additional contribution limit is $6,000 for the traditional 401(k) plan. In 2017, an employee aged 50 or older could contribute up to $24,000 to their 401(k) plan.

The amount of employer and employee contributions combined cannot be larger than the annual limit. The limit must be either (the lesser of):

  • 100% of the employee’s compensation
  • $54,000 for 2017

Plan requirements

In order to set up a 401(k) plan, you must adopt a written plan, create a trust for the plan’s assets, have a good recordkeeping system, and give information to employees about the plan.

Filing requirements

Each year, you must file Form 5500, Annual Returns/Reports of Employee Benefit Plan, if you have a traditional 401(k) plan at your small business.

Safe harbor 401(k) plans

A safe harbor 401(k) plan is another type of 401(k) you can establish. Unlike a traditional 401(k) plan, you do not need to perform annual nondiscrimination tests.

401(k) safe harbor plans are popular at small businesses because employers avoid the time and money involved in the nondiscrimination tests. However, you are required to contribute to your employees’ safe harbor plans.

Employee requirements

Like the traditional 401(k) plan, any size business can have a safe harbor 401(k) plan for its employees.

Contribution requirements

Under a safe harbor 401(k) plan, you must contribute matching contributions for employees who contribute or contribute for all employees, regardless of if they contribute or not.

When you contribute to an employee’s safe harbor 401(k) plan, keep in mind the following limits. You can do one of the following:

  • Match 100% of the contribution the employee elects to defer, up to 3% of their compensation, and match an additional 50% for each contribution that is over 3% but under 5%.
  • Contribute 3% of each employee’s compensation, regardless of if they contribute or not.

Employer contributions are required to be fully vested when they are made. That means your employee is 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. For 2017, employees can defer up to $18,000. And, the additional contribution limit for 2017 is $6,000 for the safe harbor 401(k) plan.

Like in traditional 401(k) plans, employer and employee contributions cannot go past the annual limit for safe harbor 401(k) plans. The limit must be either (the lesser of):

  • 100% of the employee’s compensation
  • $54,000 for 2017

Plan requirements

Employers are required to give each eligible employee a written notice that lists their rights and obligations. The notice must be given before each plan year, according to the IRS.

Filing requirements

File Form 5500 if you have a safe harbor 401(k) plan at your small business.

SIMPLE 401(k) plans

A SIMPLE 401(k) plan is especially for small business owners. Under a SIMPLE 401(k) plan, your contributions are nonforfeitable as soon as you contribute them. You do not need to perform nondiscrimination tests. To have a SIMPLE 401(k) plan at your business, you must meet the following requirements.

Employee requirements

You can only have a SIMPLE 401(k) plan at your small business if you have 100 or fewer employees. If your business grows and exceeds the 100-employee limit, there is a two-year grace period before you need to change your plan.

To qualify for the grace period, you must have had a SIMPLE 401(k) plan for at least one year. And, the reason you no longer qualify must be due to a growing business.

Contribution requirements

If you have a SIMPLE 401(k) plan at your business, you must contribute to your employees’ plans. Both you and your employees’ contributions are made before taxes. You are required to either make a:

  • Matching contribution of up to 3% of your employees’ wages if the employee elects to defer some of their wages
  • Non-elective contribution of up to 2% of eligible employee pay regardless of if the employee contributes

Contribution limit

Employees can only contribute up to a certain amount under a SIMPLE 401(k) plan. For 2017, the limit an employee can contribute to their plan is $12,500.

Employees who are 50 and older can contribute up to an additional $3,000 for 2017 to strengthen their retirement plan.

For example, a 51-year-old employee who is paid $40,000 each year wants to contribute the maximum amount to their SIMPLE 401(k) plan. In 2017, they can defer $15,500 from their wages to their plan. The employer makes a matching contribution of 3%. The employer would contribute $1,200 to the employee’s plan (40,000 X .03).

Plan requirements

In order to establish a SIMPLE 401(k) plan at your business, you must set up and adopt a written plan approved by the IRS. Explain the written plan to your employees.

Filing requirements

File Form 5500 if you have a SIMPLE 401(k) plan at your small business.

Solo 401(k) plans

A solo, or one-participant, 401(k) plan is a traditional 401(k) plan geared specifically for a business owner with no employees.

Unlike a traditional 401(k) plan, you do not need to conduct annual nondiscrimination testing with a solo 401(k) plan.

Employee requirements

You cannot have any employees if you want to have a solo 401(k) plan in place.

Contribution limit

In a solo 401(k) plan, you are the employee and employer. Therefore, you can contribute both of the following:

  • Up to $18,000 for 2017; up to $24,000 for people age 50 or over
  • 25% of your compensation (for a self-employed person, compensation is the amount left after deducting half of your self-employment tax and contributions)

Your total contribution (excluding catch-up contributions) cannot exceed $54,000 in 2017.

Filing requirements

Participants in solo 401(k) plans must file Form 5500-EZ, Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan.

Roth 401(k) plans

A Roth contribution program to a 401(k) plan is similar to a traditional 401(k) plan. However, contributions to a Roth 401(k) plan are considered post-tax deductions. You withhold taxes from the employee’s gross pay before you defer their wages to the plan.

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 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.

Employee requirements

Businesses of any size can offer a Roth 401(k) plan.

Contribution requirements

You can choose to match your employees’ contributions to a Roth 401(k) plan.

Contribution limit

Employees can only contribute a maximum of $18,000 to their Roth 401(k) plan in 2017. Employees age 50 or older can contribute an additional $6,000.

Filing requirements

File Form 5500 each year. For more information on Roth 401(k) plans, consult the IRS.

Types of 401(k) Plans

Automatic enrollment

You can choose to automatically enroll your employees in the 401(k) plan your business offers unless the employee elects to opt out. Any size business can create an automatic enrollment plan.

Employer tax benefits

There are many reasons employers decide to set up 401(k) plans. One benefit of establishing a 401(k) plan is that you can deduct your contribution amounts on your federal income tax return.

Your tax deduction for contributions cannot be more than 25% of the compensation you paid to your participating employees. Elective deferrals, however, do not have the 25% limit. For more information, consult the IRS.

Need help deducting employee contributions to their 401(k) plans? Patriot’s online payroll software takes out the proper deductions for each of your employees. Try it for free today!

This article has been updated from its original publish date of 05/21/2012.

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

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