401(k) Retirement Plan

A 401(k) plan allows employees to defer a percentage of their salary into an individual retirement account within the plan. Contributions are automatically deducted from each paycheck before (traditional) or after (Roth) income taxes are applied.

Traditional 401(k) Contributions: Pre-tax contributions reduce the employee's taxable income in the year they are made. For example, an employee earning $60,000 who contributes $6,000 to a traditional 401(k) is only taxed on $54,000. The contributions and investment growth are taxed as ordinary income when withdrawn in retirement.

Roth 401(k) Contributions: Post-tax contributions do not reduce current taxable income, but qualified withdrawals in retirement — including all investment growth — are completely tax-free. Many plans now offer a Roth option alongside the traditional option.

Contribution Limits (2024): Employees under age 50 can contribute up to $23,000 per year. Employees age 50 and older can make an additional $7,500 catch-up contribution, for a total of $30,500. The combined limit for employee and employer contributions is $69,000 ($76,500 for those 50+).

Employees choose how to invest their contributions from a menu of investment options offered by the plan, typically including stock funds, bond funds, target-date funds, and stable value funds.

One of the most valuable features of a 401(k) is the employer match — essentially free money for employees. Common matching formulas include:

Dollar-for-Dollar Match: The employer matches 100% of employee contributions up to a percentage of salary. Example: 100% match on the first 3% means an employee contributing 3% of a $60,000 salary ($1,800) receives an additional $1,800 from the employer.

Partial Match: The employer matches 50% of employee contributions up to a percentage. Example: 50% match on the first 6% means an employee contributing 6% of $60,000 ($3,600) receives $1,800 from the employer.

Vesting Schedules: Employer matching contributions often have a vesting schedule that determines when the employee fully owns the matched funds. Common vesting structures:

Employee contributions are always 100% vested immediately. Only employer contributions are subject to vesting schedules.

The most important advice for employees: at minimum, contribute enough to receive the full employer match. Not doing so is literally leaving free compensation on the table.

401(k) plans have strict rules about accessing funds:

Normal Withdrawals (Age 59.5+): Participants can withdraw funds without penalty after age 59.5. Traditional 401(k) withdrawals are taxed as ordinary income. Roth 401(k) withdrawals are tax-free if the account has been open for at least five years.

Early Withdrawals (Before 59.5): Generally subject to a 10% early withdrawal penalty in addition to income taxes. Exceptions include:

Hardship Withdrawals: Some plans allow hardship withdrawals for immediate, heavy financial needs such as medical expenses, purchase of a principal residence, tuition, or preventing eviction. These are subject to taxes and the 10% penalty.

401(k) Loans: Many plans allow participants to borrow up to 50% of their vested balance or $50,000, whichever is less. Loans must be repaid within five years (longer for home purchases) with interest. If the employee leaves the company, the loan balance typically must be repaid by the next tax filing deadline or it becomes a taxable distribution.

Rollovers: When leaving an employer, participants can roll their 401(k) into the new employer's plan or into a personal IRA without taxes or penalties, provided the rollover is completed within 60 days or done as a direct trustee-to-trustee transfer.

Employers sponsoring a 401(k) plan have significant fiduciary and administrative obligations:

Fiduciary Duty: Plan fiduciaries must act solely in the interest of plan participants, select and monitor investment options prudently, keep plan costs reasonable, and avoid conflicts of interest.

Non-Discrimination Testing: The IRS requires annual testing to ensure 401(k) plans do not disproportionately benefit highly compensated employees (HCEs). The Actual Deferral Percentage (ADP) test and Actual Contribution Percentage (ACP) test compare participation and contribution rates between HCEs and non-HCEs. If the plan fails, the employer must correct the imbalance — often by refunding excess contributions to HCEs.

Safe Harbor Plans: Employers can avoid annual non-discrimination testing by making mandatory employer contributions through a Safe Harbor plan. Common Safe Harbor options include a 3% non-elective contribution to all eligible employees or a 100% match on the first 3% plus 50% match on the next 2%.

Required Minimum Distributions (RMDs): Participants must begin taking distributions at age 73 (under SECURE 2.0 Act). Failure to take RMDs results in a 25% penalty on the amount not distributed.

Annual Reporting: Employers must file Form 5500 with the DOL annually, disclose plan information to participants, and distribute Summary Plan Descriptions and annual fee disclosures.