401(k) plans have become the most popular retirement plans today, thanks in large part to the perception of more and more employees that these plans are a valuable and desirable (if not necessary) benefit.
Employees can benefit from a 401(k) plan even if the employer makes no contribution. Employees voluntarily elect to make pre-tax contributions through payroll deductions up to an annual maximum limit ($16,500 in 2010 and 2011). Due to “catch-up contributions,” this limit may be higher for employees 50 and older under some plans (an additional $5,500 in 2010 and 2011).
Often, the employer will match some portion of the amount deferred by the employee to encourage greater employee participation. For example, an employer can contribute a 25% match on the first 4% deferred by the employee, or 50% for the first 5%, or pretty much any pre-established percentages the employer chooses. In addition, profit sharing contributions may be made in addition to or instead of matching contributions.
Employee and employer matching contributions are subject to a special nondiscrimination test that limits how much the group of employees referred to as “Highly Compensated Employees” can defer based on the amount deferred by the “Non-Highly Compensated Employees.” In general, employees who fall into the following two categories are considered to be Highly Compensated Employees:
- A more than 5% owner of the employer at any time during the current plan year or preceding plan year (stock attribution rules apply which treat an individual as owning stock owned by his spouse, children, grandchildren or parents); or
- An employee who received compensation in excess of the indexed limit in the preceding plan year ($110,000 for 2010 and 2011). The employer may elect that this group be limited to the top 20% of employees based on compensation.
Many employers offer employees the opportunity to take hardship withdrawals or borrow from the plan.