The 401(k) Plan is probably the most widely-used company retirement plan. The term 401(k) refers to the section of the Internal Revenue Code which permits employees to defer part of their income into a company-sponsored retirement plan. A 401(k) Plan is a great way to attract and retain employees. 401(k) Plans allow for contributions by both the employee and employer. A profit-sharing contribution can also be made by the employer. This type of contribution is at the discretion of the company. A matching contribution may also be made by the employer on behalf of the employees. This type of contribution is mandatory if that option is selected as a plan feature.
How a 401(k) Plan works
The flexibility of a 401(k) Plan allows companies to select plan features to achieve specific goals for your company and your employees. A plan must set specific eligibility requirements and vesting schedules. A 401(k) Plan may require that employees be age 21 and/or completed at least one year of employment with the company in order to participate. If the plan calls for immediate vesting, two years of employment may be required prior to becoming eligible.
Vesting is another term for ownership of the account balance and is determined mainly by the source of the funds. Contributions that employees make are always 100% vested, meaning that they always own all of the money that they contribute into the plan. Contributions that employer's make may follow a schedule in which the vesting percentage increases with each year of employment. The maximum number of years before an employee is fully vested is seven. This is at the employer's discretion and can be less than seven years.
The maximum amount of annual contributions into a 401(k) Plan is 15% of an employee's compensation or $11,000, whichever is less. Employee contributions and company matching contributions cannot be more than 25% of an employee's total compensation. Employers can alter their matching contributions from year to year.
