401(k) plans have become a widely accepted retirement savings vehicle for small businesses. An estimated 52 million U.S. workers participate in 401(k) plans that have total assets of about $3.5 trillion.

With a 401(k) plan, employees can choose to defer a portion of their salary. So instead of receiving that amount in their paycheck today, the employees can contribute the amount into a 401(k) plan sponsored by their employer. These deferrals are accounted separately for each employee. Deferrals are made on a pretax basis but, if the plan allows, the employee can choose to make them on an after-tax (Roth) basis. Many 401(k) plans provide for employer matching or other contributions. The Federal Government and most state governments do not tax employer contributions and pretax deferrals (plus earnings) until distributed.

Like profit sharing plans, A Qualified Retirement Plan document and Annual Reporting to the IRS are required for a 401(k) Plans.  Most Employers hire a Third Party Administrator for their 401(k) Plans to help reduce the administrative burden

Pros and cons

  • Allows employees an easy way to save for their own retirement
  • Can be combined with a Profit Sharing Plan so that the Employer and Employee contribute to the retirement fund
  • Flexibile contributions – contributions are strictly discretionary
  • Administrative costs may be higher than under more basic arrangements (SEP or SIMPLE IRA plans)
  • Need to test that benefits do not discriminate in favor of the highly compensated employees.

Who contributes

Employees contribute through a salary deferral feature.   The plan may be set up to allow for additional employer Profit Sharing contributions.

Contribution limits

Employees may contribute the lesser of 100% of compensation or $18,000 (for 2016, subject to cost-of-living adjustments for later years).  Employees aged 50 years and over may contribute an additional “catch-up contribution” of $6,000

Filing requirements 

Annual filing of a Form 5500-series return/report is required. Participant disclosures are also required.

Participant loans 


In-service withdrawals

Yes, but subject to possible 10% additional tax if under age 59-1/2 and no other exception applies