The Fortune Behind 401(k)s

Offering your employees a 401(k) plan can be a valuable benefit for both employees and employers. Here are a few reasons why:

1. Attracting and retaining talent: 401(k) plans are highly valued by employees because it provides them with an opportunity to save for retirement with potential employer-matching contributions. A competitive benefits package with a 401(k) plan can help attract and retain skilled employees.
2. Tax advantages: 401(k) plans offer tax advantages to employees and employers. Employees can contribute a portion of their pre-tax income to the plan, reducing their annual taxable income. Employers may also receive tax benefits, such as deductions for contributions made on behalf of employees.
3. Employee loyalty: By participating in a 401(k) plan, employees can save for retirement tax-efficiently. The contributions made by employees can grow over time through investments, and many plans offer a range of investment options to suit different risk tolerances.

Three Types of 401(k)Plans

Let’s address the difference between three 401(k) plan types.

Regular 401(k) Plan

• A 401(k) plan allows the employer to determine the level of contributions made on behalf of employees and employees to contribute a portion of their salary to the plan on a pre-tax basis. The contributions are invested and grow tax-deferred until withdrawal, typically during retirement. The IRS sets annual contribution limits for 401(k) plans, and the employer may impose additional rules and restrictions.
• However, if a regular 401(k) plan fails specific nondiscrimination tests, it may limit the contributions that highly compensated employees (HCEs) can make based on the participation and contribution levels of non-highly compensated employees (NHCEs).
• Nondiscriminatory tests: These tests are meant to maintain the plan’s qualified status under the IRS Code. The two primary nondiscrimination tests for 401(k) plans are:

1. 1. Actual Deferral Percentage (ADP) Test: The ADP test compares the average salary deferral contributions made by HCEs to those made by NHCEs. It calculates the ADP for each group and then compares the two ratios. The ADP for the HCE group cannot significantly exceed the ADP for the NHCE group. If the ADP of the HCEs is too high, corrective measures may be taken, such as returning excess contributions to highly compensated employees or providing additional contributions to non-highly compensated employees.
   2. Actual Contribution Percentage (ACP) Test: The ACP test is similar to the ADP test but focuses on employer-matching contributions and employee after-tax contributions instead of salary deferrals. It compares the average employer matching and after-tax contributions made on behalf of HCEs to those made on behalf of NHCEs. The ACP for the HCE group should not significantly exceed the ACP for the NHCE group. Suppose the ACP of the HCEs is too high. In that case, corrective actions may be required, such as returning excess contributions to highly compensated employees or providing additional contributions to non-highly compensated employees.

Safe Harbor 401(k) Plan

• A safe harbor 401(k) plan is designed to satisfy specific IRS nondiscrimination requirements automatically. The provisions ensure the plan is available and beneficial to all eligible employees, including those with lower incomes.
• Safe harbor plans must satisfy specific contribution requirements, such as employer matching contributions or a non-elective contribution to the plan on behalf of all eligible employees provides a more favorable framework for HCEs to save for retirement.
• By meeting specific contribution and notice requirements, a safe harbor plan allows HCEs to maximize their contributions without being subject to the usual nondiscrimination testing.

SIMPLE 401(k) Plan

• The Savings Incentive Match Plan for Employees (SIMPLE) 401(k) plan was created so that small businesses could have an effective, cost-efficient way to offer retirement benefits to their employees. A Simple 401(k) plan is not subject to the annual nondiscrimination tests that apply to traditional 401(k) plans.
• It offers simplified administration and lower compliance requirements than traditional 401(k) plans. Employers must match employee contributions up to a certain percentage or make non-elective contributions to eligible employees’ accounts.
• As with a safe harbor 401(k) plan, employers must match employee contributions up to a certain percentage or make non-elective contributions to eligible employees’ accounts.
• This type of 401(k) plan is available to employers with 100 or fewer employees who received at least $5,000 in compensation from the employer for the preceding calendar year. Employees eligible to participate in a Simple 401(k) plan may not receive any contributions or benefit accruals under any other employer plans.

PT Business Solutions and Saving Plans

It is essential to consult with specialists like PT Business Solutions because we are qualified financial advisors and employee benefits specialists. We can help you determine which type of plan suits your organization based on its unique circumstances, goals, and resources.