Types of 401k Plans

As you begin to think about saving for retirement, it’s important to understand the different retirement plans available to you. One of the most popular types are 401(k) plans. Stemming from section 401(k) of the U.S. tax code, 401(k) plans are employer-sponsored retirement plans that allow employees to save for retirement. There are numerous types of 401(k) plans that might be available to you.

Whether you’re a small business owner that wants to offer 401(k) plans to your employees or a worker wondering what a 401(k) is, we’re here to help. Below, we’ll go over the various types of 401(k) plans that you might come across. Keep reading to learn about each type of 401(k) plan or use the links below to learn more about a specific type of 401(k) plan.

• The traditional 401(k) plans
• Roth 401(k) plans
• Safe harbor 401(k) plans
• SIMPLE 401(k) plans
• Solo 401(k) plans
• Final thoughts

Types of 401(k) plans

401(k) plans are employer-sponsored retirement plans that allow employees to contribute a certain amount of each paycheck to their savings. Employee contributions are put toward investment options like stocks, bonds, or mutual funds. Under the Employee Retirement Income Security Act (ERISA) of 1974, 401(k) plans are considered a defined contribution plan or benefit plan. This means the plan must promise a specified monthly benefit during retirement.

Employee contributions can be either pre-tax or post-tax, depending on the plan’s structure. These tax benefits can affect an employee’s taxable income during the year they contribute or when they make withdrawals during retirement. The different types of 401(k) plans include the following:

• Traditional 401(k) plan
• Roth 401(k) plan
• Safe harbor 401(k) plan
• SIMPLE 401(k) plan
• Solo 401(k) plan

Let’s take a look at how each type of 401(k) plan works.

The traditional 401(k)

Most employers choose to offer traditional 401(k) plans as a benefit to their employees. Employee contributions to a traditional 401(k) are tax-deferred. This means that employees won’t pay any income tax on their contributions until they make withdrawals in retirement. These withdrawals will then be taxed as ordinary income. Traditional 401(k) plan contributions can lower an employee’s taxable income for the year, which can place them in a lower tax bracket. When that happens, they’ll owe less in federal income, Social Security, and Medicare taxes.

Plan requirements

To open a 401(k) to your employees, outline a plan document that complies with all IRS rules and regulations. As the employer, you’re responsible for the plan, so you must maintain compliance. This means knowing what your service agreement does and doesn’t cover, staying in contact with your plan’s service provider, and informing participating employees about the plan’s details.

Filing requirements

Employers or their plan administrators are responsible for filing Form 5500 . This form reports information on the plan’s qualifications, financial condition, investments, and operations. To ensure that you’re accurately reporting this information, try QuickBooks’ payroll software . Our payroll software allows you to maintain accurate payroll records and find small business tax deductions you’re eligible for, including 401(k) employer contributions.

Employee requirements

Employees must meet eligibility requirements in order to contribute to an employer-sponsored 401(k) plan. To be eligible for a 401(k) plan, employers must pass nondiscrimination tests to ensure that highly-compensated employees aren’t the only ones benefiting from the plan. These annual tests are known as the actual deferral percentage (ADP) and actual contribution percentage (ACP) tests.

For an employee to receive matching contributions, they must also meet the following eligibility requirements:

• Employee must be 21 years of age or older
• Employee must have at least one year of service

Additionally, employees can’t make withdrawals until they reach the age of 59½ and must take required minimum distributions when they reach 72 years of age. Withdrawals made before this can result in additional penalties and fees.

Contribution requirements

As an employer, there are a few contribution requirements worth noting. You can offer an employer match for all participants, even if they don’t contribute; make matching contributions based on a workers’ elected deferrals; or both.

Contributions might be subject to a vesting schedule . This determines how many years an employee must work at a company (years of service) before receiving a percentage of an employer’s contribution. For example, an employee might have to work for two years before receiving a 20% vested interest in their employer’s contribution.

Contribution limit

The Internal Revenue Service (IRS) sets annual contribution limits that specify how much an employee can contribute to their 401(k) plan. The contribution limits for traditional 401(k) plans are:

• $19,500 for 2021
• $19,500 for 2020
• $19,000 for 2019

For 401(k) plan participants aged 50 or older, the IRS allows catch-up contributions. These additional contributions make it easier for those nearing retirement to begin saving more. The catch-up contributions are as follows:

• 2021: $6,500
• 2020: $6,500
• 2019: $6,000

Roth 401(k) plan

A Roth 401(k) plan is very similar to a traditional 401(k) plan; the main difference lies in the tax breaks it receives. Rather than contributing with pre-tax dollars, contributions to a Roth 401(k) are made with after-tax dollars, which mimics how Roth IRAs work.

Because contributions to Roth accounts are made with post-tax dollars, withdrawals made during retirement are tax-free. This tax advantage applies to any income earned through interest, capital gains, or dividends.

Plan requirements

If you offer a Roth 401(k), you must also provide a traditional 401(k). Just like traditional 401(k) plan requirements, it’s important to comply with IRS laws and regulations. This means knowing what your service agreement does and doesn’t cover, staying in contact with your plan’s service provider, and informing participating employees about the plan’s details.

Filing requirements

Employers must file Form 5500 annually.

Employee requirements

Like traditional 401(k) plans, employers must pass nondiscrimination testing to ensure all employees are treated fairly. Employees can’t make withdrawals until they reach the age of 59½ and must take required minimum distributions when they reach 72 years of age. Taking withdrawals before this can result in additional penalties and fees.

Contribution requirements

Similar to traditional 401(k) plans, employers aren’t required to make matching contributions. However, businesses can decide to offer an employer match up to a certain contribution limit. For example, an employer might offer a 50% match on 6% of an employee’s income.

Contribution limit

The contribution limits for Roth 401(k) plans are the same as traditional 401(k) plans:

• $19,500 for 2021
• $19,500 for 2020
• $19,000 for 2019

The catch-up contributions also remain the same:

• $6,500 for 2021
• $6,500 for 2020
• $6,000 for 2019

Safe harbor 401(k) plans

A safe harbor 401(k) plan is a special type of 401(k) plan that automatically passes the nondiscrimination test required by traditional and Roth 401(k) plans. Many small businesses choose this type because passing nondiscrimination tests can be costly. They are similar to traditional 401(k) plans, but employers must make fully vested contributions to an employee’s safe harbor plan.

Plan requirements

Safe harbor 401(k) plans require employers to meet certain notice requirements. The notice requirement is satisfied when the employer gives each eligible employee a written notice that details the employee’s rights and obligations under the plan. This notice must also meet the following content and timing requirements:

• Content requirements: The notice must describe the safe harbor method being used, how eligible employees make elections, and any other plans involved.
• Timing requirements: Employers must provide notice within a reasonable period before each plan year. This requirement is satisfied if employees provide notice to eligible employees at least 30 days and not more than 90 days before the beginning of each plan year.

Filing requirements

Employers file Form 5500 for safe harbor 401(k) plans.

Employee requirements

Employees cannot withdraw from a safe harbor 401(k) until they reach 59½ years of age or they might face a 10% penalty.

Contribution requirements

Employers must make contributions to an employee’s safe harbor 401(k), and these contributions must be fully vested. Employers can make either matching or nonelective contributions .

Employers have two options for safe harbor matching contributions:

• Basic match: Provides 100% match on the first 3% of deferred compensation, plus an additional 50% match on deferrals between 3% and 5%
• Enhanced match: Provides at least a 100% match on the first 4% of deferred compensation

Or, employers can make a safe harbor nonelective contribution, which is 3% or more of compensation, regardless of employee deferrals.

Contribution limit

The contribution limits for safe harbor 401(k) plans are the same as traditional 401(k) plans:

• $19,500 for 2021
• $19,500 for 2020
• $19,000 for 2019

The catch-up contribution limits are also the same:

• $6,500 for 2021
• $6,500 for 2020
• $6,000 for 2019

SIMPLE 401(k) plans

SIMPLE 401(k) plans are a stripped-down version of traditional 401(k) plans and are suitable for small businesses that want to offer retirement benefits. Employers with 100 or fewer employees are eligible to offer a SIMPLE 401(k) plan. Like a safe harbor 401(k) or SIMPLE IRA, SIMPLE 401(k) plans don’t need to pass nondiscrimination tests. However, employers must make vested contributions that are nonforfeitable. Additionally, employees participating in a SIMPLE 401(k) cannot receive any contributions or accruals from other employer-sponsored retirement accounts.

Plan requirements

SIMPLE 401(k) plans can be offered to employees of businesses with 100 or fewer employees who earn at least $5,000 in annual income. Employers must create a written plan, get it approved by the IRS, and explain plan details to employees.

Filing requirements

Employers file Form 5500 if they offer a SIMPLE 401(k) plan.

Employee requirements

Employees cannot withdraw from a SIMPLE 401(k) until they reach 59½ years of age or they might face a 10% or 25% penalty .

Contribution requirements

To establish a SIMPLE 401(k) plan , employers must either make a matching contribution up to 3% of each employee’s pay, or make a nonelective contribution of 2% of each eligible employee’s pay. No other contributions can be made, and employees are totally vested in any and all contributions.

Contribution limit

The employee contribution limits for SIMPLE 401(k) plans are as follows:

• $13,500 in 2021
• $13,500 in 2020
• $13,000 in 2019
• $12,500 in 2018

If the employee is age 50 or over, an additional catch-up contribution is allowed, which is:

• $3,000 in 2021, 2020, 2019 and 2018

Solo 401(k) plans

Lastly, a solo 401(k) plan is designed specifically for self-employed business owners who have no other employees apart from a spouse or business partners. This type of 401(k) can also be referred to as an individual 401(k) or self-employed 401(k). With a solo 401(k) plan, participants can make contributions as both an employer and employee to maximize their retirement plan contributions and business deductions.

Plan requirements

If you’re a self-employed worker and have an EIN, you’re eligible to open a solo 401(k). If you don’t have any common-law employees, you don’t need to perform nondiscrimination testing.

Filing requirements

Participants must file IRS Form 5500-EZ annually.

Employee requirements

Self-employed workers can contribute as an employee up to the contribution limit of $19,500 . They cannot make withdrawals until they reach the age of 59½ or they might face a 10% penalty.

Contribution requirements

As a self-employed worker, you have the option of contributing as an employer, employee, or both.

Contribution limit

The solo 401(k) owner can make two types of contributions :

• Elective deferrals up to 100% of compensation to the contribution limit of $19,500 for 2020 and 2021, along with a catch-up contribution for those aged 50 and older of $6,500 for 2020 and 2021
• Additional profit-sharing plan contribution up to 25% of your compensation as defined by your plan

Total contributions cannot exceed $57,000 for 2020 or $58,000 for 2021.

Final thoughts

There is no single right answer when it comes to choosing a 401(k) plan. As an employer, work with your financial advisor to determine which type of 401(k) plan will benefit your company the most. As an employee, make sure you know the details of the 401(k) plan your employer offers to maximize your retirement savings.

At QuickBooks, whether you’re conducting payroll for remote employees or want to stay tax-compliant, our payroll software can help. We provide numerous employee payroll services such as HR support, workers’ compensation, health benefits, 401(k) plans, and more.