A 401k is a qualified retirement plan that allows eligible employees of a company to save and invest for their own retirement on a tax deferred basis. Only an employer is allowed to sponsor a 401k for their employees.

A traditional 401(k) Plan is a defined contribution plan

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A traditional 401(k) Plan is a defined contribution plan which:

  • Allows Employees to make elective deferrals through payroll deductions and direct the investment of their contributions.
  • Employee contributions are always 100% vested and can be made in the form of pre-tax or ROTH contributions, regardless of their income limit.
  • A match or a profit sharing feature may be added to the plan and may be subject to a vesting schedule for the company portion of the account.
  • The Employer may limit eligibility for the plan.

When a 401(k) feature is added to a qualified plan, participants can choose between receiving their pay in cash and deferring it before taxes into the qualified plan. A 401(k) Plan can be a stand-alone plan (i.e. employee salary deferrals only), or it can be a feature added to Profit Sharing or Stock Bonus Plan.

A 401(k) Plan can accept both employee and employer contributions. Allowable employee contributions are voluntary pre-tax salary deferrals, voluntary Roth salary deferrals, voluntary after-tax contributions (i.e. a “thrift plan”) and mandatory after-tax contributions. Non-Roth after-tax contributions are rare these days. Employer contributions include discretionary profit sharing contributions, discretionary and formulaic matching contributions (based on the employees’ voluntary salary deferrals) and mandatory safe harbor contributions. All of the money-types are separately sourced for accounting purposes, and account statements for participants typically detail the portions of their accounts attributable to each money-type, including investment gains and losses.

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