What is a 401(k) Plan
A 401(k) Plan is an employer sponsored retirement program allowed under Section 401(k) of the Internal Revenue Code (IRC).
Generally, under this type of program, employees are provided with the opportunity to defer part of their salary on a
pre-tax basis. At times, these arrangements also allow for different forms of employer contributions that are used to
supplement employee savings for retirement.
Why do employers adopt 401(k) Plans?
Employers may have several reasons for adopting 401(k) Plans. Some reasons relate to human resource issues, such as
attracting and retaining employees. Further, employers may be entitled to tax deductions for their contributions to the plan
or may simply want to assist their employees in securing a financial plan for retirement.
What are the benefits of a 401(k) plan versus other retirement plans?
In general, 401(k) plans can be suitable for companies with any employees. In comparison to other retirement plans, 401(k)
plans can offer the following benefits: higher contribution limits contributions on a pre-tax basis (up to the annual
IRS limit) vesting schedules for employer contributions pre-retirement access to account assets through loans. In order
to offer these features, 401(k) plan sponsors must follow certain legal and administrative guidelines.
What are the tax advantages?
Participants in your 401(k) plan can reduce their current federal and, in most cases, state and local taxes by making
contributions on a pre-tax basis. Account assets can grow tax-deferred until withdrawn, which can help participants
accumulate substantially more than they would in a comparable taxable investment. In addition, any contributions your
company makes to your employees' accounts are generally tax deductible as a business expense.
Who can establish a 401(k) Plan?
A 401(k) Plan may be established by any sole proprietor, partnership, or corporation, and by certain non-profit
organizations. State and local governments are prohibited from adopting a 401(k) Plan.
How does a business establish a 401(k) plan?
Because a 401(k) plan is a "qualified" plan (i.e. it enjoys current beneficial tax treatment), it must be established
pursuant to a written plan and trust document, which meets certain requirements stipulated by law. Contributions to
the plan are deposited to a trust, which is managed by a trustee appointed by the employer. The trustee can be a
financial institution such as a bank or trust company or it can be one or more individuals such as the officers or
owners of the employer.
How long does it take to set up a plan?
Starting a 401(k) plan is fairly easy and can typically be completed in just 30 minutes, using our online system.
(This is substantially different than the typical 10-12 weeks in can take to set-up a 401k Plan with a traditional
offline provider.) Starting a new 401(k) plan is easy. Simply go to the website, and complete steps 1-5.
Gathering the following information before hand will be beneficial to you and will speed up the establishment process.
You will need:
- Your company's Tax ID number
- Employee names, social security numbers and estimated yearly pay.
- Employee dates of hire and birth dates.
Additional information is required, however, you will be guided through the website step-by-step.
How much does it cost to set up a plan?
Traditional 401(k) Plans can cost as much as $5,000/year in administrative fees, for even the smallest employer.
But we have been able to change the dynamics of this business by using the Internet and automation to cut costs.
This enables us to offer 401(k) Plans to employers at considerably lower costs to the employers.
What does a 401k offer small businesses?
According to industry surveys, the most commonly cited reason for not offering an employer-sponsored retirement plan have
been high cost and lack of access to competitive alternatives. Our 401(k) has been specifically designed to overcome these
hurdles and provide small businesses with a comprehensive, low cost alternative.
- Affordable - The efficiencies and dynamics of the Internet allow us to offer a 401(k) Plan that is very low
cost to the employer, and extremely cost competitive for employees.
- Convenient - Our online service is available 24-hours-a-day, seven days a week. So employers and employees
can access their plan information from anywhere, anytime at their discretion.
- Comprehensive - Our 401(k) is the first comprehensive online plan, including employee communication and
financial education, as well as a daily valued record-keeping solution and a wide range of investment flexibility.
Our online solution is supported by telephone voice-response systems and operator assistance to ensure that you and
your participants receive superior customer service.
- Easy - We have streamlined the entire administrative process for both employers and employees. Everything is
handled on our site, from plan set-up and employee enrollment through payroll tracking and participant reporting. We can
be fully integrated with all major payroll software and service providers and provide real-time assistance to both
employers and employees needs.
- Secure - We utilizes the latest encryption technology to ensure a safe and secure environment for your personal
financial information. We are Verisign certified and TrustGuard endorsed.
What investment options are available?
We provide a wide array of mutual funds, ranging from conservation bond funds to aggressive growth and international
funds. For those who do not want to participate in the market, we also provide a Money Market fund, which is similar to
a cash account.
Is our information safe?
Yes! We do not release any client or employee information to anyone but the employer sponsoring the 401(k) Plan.
We are a secured-encrypted site that utilizes the latest technology to ensure the safety of your confidential information!
What is a Plan Number?
The Plan Number is a designation mandated by ERISA, which denotes the sequence and total number of qualified plans
maintained or established by an employer. The number appears on the Form 5500 (Annual Report) for every plan and must be
designated. It is typically three digits (i.e. 001).
What is a Control Group?
A Control Group is a collection of multiple corporations with overlapping ownership, which the Internal Revenue Code
views as a single employer for various plan testing purposes. This is commonly perceived to eliminate the
"loop-hole" whereby multiple companies are set-up to circumvent the Non-Discrimination tests.
What is an Affiliated Service Group?
An Affiliated Service Group is a collection of separate individuals or business entities that possess a combination of
common ownership and joint activity. The Internal Revenue Code considers members of an affiliated service group to
constitute a single employer for various plan-testing purposes. This is commonly perceived to eliminate the "loop-hole"
whereby owners of multiple companies defer more than the maximum limits within multiple retirement plans.
What is a Negative Enrollment Election?
Negative election is a means of enrolling employees in a qualified plan that requires them to elect not to participate.
So, the employer automatically enrolls all eligible employees, and then offers a time period for them to withdraw from the plan.
This technique is commonly practiced among many of the largest employers in the U.S.
and has been deemed acceptable by the U.S. Dept. of Labor.
What is vesting?
In addition negative elections can enable Highly Compensated Employees (HCE) of employer-sponsors to contribute more often
to their own plan accounts, because it can help enable a plan to pass its non-discrimination tests more easily. But at the
end of the day, negative election is a choice made by the employer-sponsor
Employees are always entitled to the amounts they contribute under the plan. An employee may also be entitled to all or
a portion of any contribution made by the employer. The amount of the employer contribution the employee would be
entitled to is dependent upon the vesting schedule provision adopted by the employer. A plan may require the employee
to complete a certain number of years of service with the employer before these contributions become fully theirs.
Some plans provide for a graduated vesting schedule, so that the employee can earn a right to a portion of their
employer contributions as they complete a specified number of years of service.
How do pre-tax contributions work?
Each payroll period, the amount the employee has elected to contribute to the plan is automatically deducted from the
employee's paycheck and deposited to the plan by the employer. The amounts deferred by the employee are subject to FICA
and FUTA taxes. However they are not subject to Federal, State, or local income taxes, except in Pennsylvania.
Therefore a 401(k) Plan is an ideal way for an employee to reduce his taxable income while saving for retirement.
Earnings on contributions to the plan also accumulate on a tax-deferred basis.
What is non-discrimination testing?
The IRS requires a series of mathematical tests that ensure that the average percentage of salary contributed by highly
compensated employees is not excessive when compared with those contributions made on behalf of the lower paid employees
What is the definition of a Highly Compensated Employee?
"Highly Compensated" employees (HCE) for purposes of ADP/ACP testing are employees who are in any of the
- Any employee who owns more than 5% of the business at any time during the current or prior year.
- An employee with compensation in excess of $130,000.01 (as indexed) in the prior year.
- Certain family members of a highly compensated employee who are attributed stock ownership.
Are there any special exceptions to the amounts that employees are permitted to contribute?
Yes. Generally "Highly Compensated Employees" are not permitted to contribute to the plan in an amount that is more
than 1.25% of the amount of the other employees. This amount is determined as an average based on the contributions as a
percentage of compensation. For example, the "highly compensated employees" average contribution rate cannot be above 10%
if the other employees' rate is 8% (8% x 1.25% = 10%)
What happens if the 1.25% limit is exceeded?
Generally, the plan must return some salary deferrals to highly compensated participants. If the plan does not satisfy
either the 1.25 ration test or the alternative test, the plan must either distribute excess deferrals to highly
compensated participants sufficient to reduce the highly compensated ADP to an acceptable level or special contributions
must be made by the employer on behalf of non-highly compensated participants sufficient to raise their ADP to an
acceptable level. This type of contribution is called a QNEC, (Qualified Non-Elective Contribution). Either approach
can be expensive or result in unfavorable tax impact on highly compensated employees.
What are the limits on the amount of contributions to the plan?
There is a plan total limit and an individual employee limit. Plan Total Limit - Because a 401(k) plan is a "qualified"
plan, plan contributions are deductible by the employer up to 25.0% of total eligible employee compensation for the year.
All types of contributions (deferrals, matching, and profit sharing) are aggregated for purposes of this limit.
Individual employee percentages do not matter, some could be greater than 25.0% as long as the total contributions for all
employees do not exceed 25.0% of the total compensation of all employees. Salary deferral contributions are included in
this limit because the employer takes a plan contribution deduction for salary deferrals (rather than the deduction he
would take for employee compensation had the amounts been paid as compensation rather than contributed to the plan).
Individual Employee Limit - Individual employees are subject to two limits. One is strictly on salary deferrals, which
cannot exceed $19,500.00 (indexed annually) for a calendar year. The other limit is on the aggregate of all contributions
(deferrals, matching, profit sharing, along with any reallocated forfeitures) allocated on the employee's behalf.
Those contributions in the aggregate cannot exceed 100.0% of the employee's compensation for the year, or $58,000.00, whichever
What happens to the salary deferrals that are deposited to the Plan as contributions?
- According to the Department of Labor, (DOL), employers are supposed to deposit the money as soon as they are able to
determine the total amount of the deposit. This elusive definition allows the employers some latitude but generally,
employers should deposit employee contributions within two days after contributions are deducted. The contributions
are deposited to the plan's trust account and invested per the employee's allocation instructions.
- These instructions are generated when the employee selects his investment options during the enrollment process.
The employee can reallocate his/her investment options for future contributions at any time.
- The plan makes available a menu of investment options. The menu typically includes mutual funds representing a
variety of investment objectives: a balanced fund, equity fund, money market fund, and a fixed or guaranteed fund.
How are 401(k) plans administered?
Because administration of 401(k) plans is fairly complex, most employers engage the services of an outside custodian and
recordkeeper to provide services for the plan. The recordkeeper and custodian may be the same firm or separate entities.
The custodian receives plan contributions, makes investments, manages the activities of the trust accounts, and provides
periodic financial reporting on the trust to the employer. The plan recordkeeper maintains records on participant accounts
under the plan, tests the plan for discrimination (ADP testing), provides periodic statements or statement information
via electronic file to plan participants, processes participant loans and withdrawals, prepares annual returns required
by the IRS, and provides assistance in drafting a plan document. The employer's responsibilities are to enroll
participants as they become eligible, process payroll deductions, compute employer-matching contributions, provide the
plan administrator periodic census and status information on employees and evaluate employee applications for participant
loans and withdrawals.
How many investment options must be offered under a 401(k) Plan?
Employers may offer as many investments as they deem appropriate. However there are guidelines under Section
404(c) of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"). These guidelines provide
recommendations as to the number and scope of the investment offerings that an employer may choose to make available
to plan participants, and require a minimum of three investments with differing risk/return characteristics.
Note: Section 404(c) is a complicated provision of ERISA and contains a variety of provisions that must be met to
qualify for its Safe Harbor provisions. Consult your legal counsel for details.
Can an employer exclude employees from participating under a 401(k) Plan?
Generally, all employees must be offered the opportunity to participate in the plan. The employer may set certain age and
service requirements that employees must reach before becoming eligible to participate under the plan. (There are minimums
and maximums in both categories: Age = not greater than 21, or less than 18; Service = not greater than one year, no
minimum.) The employer can also exclude classifications of employees such as hourly paid, commissioned salesmen, etc.
However, the effect of these exclusions cannot be discriminatory (i.e. result in the plan being less available to non-highly
compensated employees than it is to highly compensated employees. Imposing any classification exclusions involves special
testing of the plan each year to ensure the effect is not discriminatory; hence, most small to medium sized plans do not
impose these restrictions so that the need for testing and potential problems are avoided. Note: Certain groups may be
permanently excluded from a plan, provided several Sections of the IRC and other applicable laws are satisfied.
Example: Employees covered by Collective Bargaining Agreements, Union Plans, or non-resident aliens.
Must all employees contribute under the 401(k) Plan?
No. While employees who are eligible to participate under the 401(k) Plan must be given the right to participate, they
are not obligated to contribute to the plan