More and more employees perceive 401(k) plans as a valuable benefit which have made them the most popular retirement plans today. 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 2009 and $16,500 in 2010).
The plan may also permit employees age 50 and older to make additional "catch-up contributions" up to an annual maximum limit ($5,500 in 2009 and $5,500 in 2010).
Often the employer will match some portion of the amount deferred by the employee to encourage greater employee participation, i.e., 25% match on the first 4% deferred by the employee. Since a 401(k) plan is a type of profit sharing plan, profit sharing contributions may be made in addition to or instead of matching contributions. Many employers offer employees the opportunity to take hardship withdrawals or borrow from the plan.
Employee and employer matching contributions are subject to a special nondiscrimination test which 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 2009). The employer may elect that this group be limited to the top 20% of employees based on compensation.
401(k) Safe Harbor Plans: The plan may be designed to satisfy "401(k) Safe Harbor" requirements (certain minimum employer contributions and 100% vesting of employer contributions) which can eliminate nondiscrimination testing. The benefit of eliminating the testing is that Highly Compensated Employees can defer up to the annual limit ($16,500 in 2009 and 16,500 in 2010) without concern for what the Non-Highly Compensated Employees defer.