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This page is updated several times a year since 401k regulations change frequently.


This course will provide you with a basic understanding of 401k plans. We will cover the following topics:
  • Logistics - How a typical 401k operates
  • Sample Vesting Schedule
  • Who is eligible to participate in a 401k?
  • 401K Benefits - For the Employer, and for the Employee
  • 401k Administration Expenses: How much does it cost and who pays the bills?

    Understanding 401ks can provide a key (or a benchmark) to help you understand and remember the basics of other retirement plans, like SEPs, Defined Benefit plans, etc.
    For example: You could remember the basics of a 'SIMPLE' plan by comparing it to a 401k in this way:
    'A SIMPLE plan is like a 401k for small businesses, except there is no complicated plan document, no 5500 filing requirement, the annual limits are lower, and there are only two funding options for company contributions'.

    The material covered (in the 401k Basics section) is designed for a beginner or novice; but the tables, terms and acronyms will be helpful to just about everyone interested in 401ks.

      A (so called) 401k plan is an employer-sponsored retirement savings plan. "401k" refers to Internal Revenue Code Section 401(k), which makes 401k plans a deductible company expense. A 401k is a "Qualified" benefit plan, meaning strict rules must be followed so certain expenses can be DEDUCTIBLE for the employer and EXEMPT for the employee. We'll talk further about Deductions and Exemptions when we discuss 401k benefits.

      401k is one of the few options available for people who want to save a large amount of money for retirement. Employees can withhold up to $15,500 from their wages in 2008 via 401k: This is much higher than an IRA or a Roth IRA. Employers can match employee deductions, or make contributions to employees' accounts. In 2008, an employee could have as much as $46,000 contributed to his account. The $46,000 limit applies to withholdings and contributions combined: If an employee is 50 years old or more, this limit is increased by $5,000. See the table below for more information about 401k limits by year.

    Logistics - How a typical 401k operates:

    An individual cannot open a 401k retirement account: You can only join a 401k plan if it is made available by your employer. Ask your employer if you are not sure if your company has a 401k.

      Each participating employee gets a 401k account in their name for 401k withholdings. Employees are given the option of withholding a certain amount of money from their paycheck - either a flat dollar amount or a percentage of their pay. The amount withheld is invested into their 401k account. This account belongs to the employee. The employee can take this money with them if/when they leave the company. It is not a company asset. It is the employee's money.

      Employees are also given a choice of investments for their withholdings. Investment alternatives differ from company to company. Available investment alternatives have usually been reviewed and approved by a Professional Investment Advisor. Many companies provide several groups of investments based on risk tolerance and the amount of time left till retirement.

      Employer contributions to 401k accounts:
      Employers can elect to make contributions on behalf of their employees. Contributions could be in the form of matching funds, a percentage of gross pay, or they could be a discretionary amount based on the profitability of the company. Companies must adhere to a strict set of rules regarding employer contributions. These rules are outlined in a 401k plan document. Plan documents are a set of guidelines that the 401k must follow. All plan documents must be approved by the IRS.

      Employer contributions are generally made into a separate account in the employee's name - separate from the employee's withholding account. Though this account is in the employee's name, the money may not belong to the employee right away. Employer contributions often become the property of the employee slowly over time. This process is called "Vesting". A typical Vesting Schedule might look like this:

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    Statutory Limits for Traditional 401k Plans - By Year:

    YearHCE Salary LimitTotal Comp. LimitEmployee W/H LimitCatch up Cont. LimitAnnual Benefit LimitTop Heavy Comp. Limit:
    Officer / 1-4.99% owner
    2014 115,000 260,000 17,500 5,500 52,000 170,000 / 170,000
    2013 115,000 255,000 17,500 5,500 51,000 165,000 / 165,000
    2012 115,000 250,000 17,000 5,500 50,000 165,000 / 165,000
    2011 110,000 245,000 16,500 5,500 49,000 160,000 / 160,000
    2010 110,000 245,000 16,500 5,500 49,000 160,000 / 160,000
    2009 110,000 245,000 16,500 5,500 49,000 160,000 / 160,000
    2008 105,000 230,000 15,500 5,000 46,000 150,000 / 150,000
    2007 100,000 225,000 15,500 5,000 45,000 145,000 / 150,000
    2006 100,000 220,000 15,000 5,000 44,000 140,000 / 150,000
    2005 95,000 210,000 14,000 4,000 42,000 135,000 / 150,000
    2004 90,000 205,000 13,000 3,000 41,000 130,000 / 150,000
    2003 90,000 200,000 12,000 2,000 40,000 130,000 / 150,000
    2002 90,000 200,000 11,000 1,000 40,000 130,000 / 150,000

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    Statutory Limits for S.I.M.PL.E. Plans - By Year:

    Year Total Comp. Limit Employee W/H Limit Catch up Cont. Limit
    2014 260,000 12,000 2,500
    2013 255,000 12,000 2,500
    2012 250,000 11,500 2,500
    2011 245,000 11,500 2,500
    2010 245,000 11,500 2,500
    2009 245,000 11,500 2,500
    2008 230,000 10,500 2,500
    2007 225,000 10,500 2,500
    2006 220,000 10,000 2,500
    2005 210,000 10,000 2,000
    2004 205,000 9,000 1,500
    2003 200,000 8,000 1,000
    2002 200,000 7,000 500

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    Pension Administrators have a language all thier own. If you don't know the terms that are unique to the industry, you could have trouble understanding them.


      Average Contribution Percentage: The amount contributed to the 401k plan by the employer.
      The average is calculated by using the Percentage contributed for each eligible employee.


      Average Deferral Percentage: The amount contributed to the 401k plan by the employees.
      The average is calculated by using the Percentage of each eligible employee.

      Automatic Enrollment

      If you want to increase participation in your 401k, you have an option to automatically enroll employees, rather than waiting for them to take initiative. 401ktest.com does not recommend this, but the IRS is taking aggressive steps to encourage companies to do this.
      You must give the employee at least 30 days notice that they are going to be automatically enrolled. The notice should let them know about the provisions of the plan, the investment alternatives, and you must inform them that they have the option to say no.
      You can also pick an investment for employees who do not choose one. You should follow the following procedures, outlined by the IRS, when choosing an investment for your employees who won't choose for themselves:

      1. The investment must be a QDIA - qualified default investment alternative:
      Company securities are not banned as a QDIA, but they are discouraged and they are restricted.
      The investments must be managed by a Qualified Investment Manager. If the plan sponsor is managing the assets, she/he should use a qualified consultant.
      Investment alternatives should be one of the following types (in accordance with 404c):
      • 'Lifecycle' funds or 'Targeted retirement date' funds: Funds that target a retirement date and adjust their risk accordingly.
      • 'Balanced Funds': A portfolio that is diversified to mitigate the risk of large losses and provide Long-Term appreciation and capital preservation - A mix of Equity and Fixed income products.
      • 'Managed Account': There are no default investment specifications for actively managed accounts, but managed accounts are required to consider the investors' age and/or expected years till retirement as a factor in determining the overall risk of the investments made.
      2. The participant must have the option to direct their own investments.
      3. They must receive information about the default investment(s) 30 days prior to when the first investment is made.
      4. All materials provided to the plan sponsor (regarding the investment) must also be provided to the participants holding the default investment(s).
      5. Participants must be able to roll their investments into other opportunities without penalty. This doesn't mean that they should be put in a better position than other participants, but that they cannot be put into a more restrictive position than others.
      6. Plans must offer a "broad range" of investment alternatives - in accordance with 404c.
      If your plan is restricted to only a few mutual funds, and if you initiate automatic enrollment, you may not be able to meet the burden of providing a 'broad range' of investment alternatives.

      Catch-up Contribution

      If you are 50 or over, the simple contribution limit is increased by this amount.
      Catch-up contributions are NOT SUBJECT TO HCE TESTING if they become the reason for a test failure.


      Sometimes also called Tiering or New Comparability. This is a technique that allows contributions to be made based on employee classifications and the future value of the contribution at retirement age. Cross-testing may be an option for Prototype 401k plan in 2008.
      Cross-testing is complicated, but it can provide a great value to privately held companies who are careful about how they spend their benefit dollars.

      Current Year Test

      Compliance test allowed for testing HCE contribution limits. Current year payroll information is used to set HCEs contribution or deferral limits.

      Prior Year Test

      Compliance test allowed for testing HCE contribution limits. Prior year payroll information is used to define current year limits.


      GUST is an acronym derived from the abbreviations used to describe several pieces of legislation. These abbreviations are defined below:
      • The Uruguay Round Agreements Act ("GATT")
      • The Uniformed Services Employment and Reemployment Rights Act ("USERRA")
      • The Small Business Jobs Protection Act ("SBJPA")
      • The Taxpayer Relief Act ("TRA")
      A few key points of the above (laws which were passed between 1994 and 1997) include: A change in definition of Highly Compensated Employee; Repeal of Family Aggregation rules used in compliance testing; Definition of compensation now includes elective deferrals for annual addition limits; Change in how matching contributions are handled for self-employed individuals; Change in required minimum distribution rules for employed participants; Creation of new 401(k) discrimination testing options; Repeal of Five year averaging; And much more…

      GUST II

      aka Full GUST: The Internal Revenue Service opened the determination letter program to allow sponsors of individually designed plans to obtain determination letters that take into account all the changes in the qualification requirements made by GUST, including those changes made by SBJPA that are first effective in plan years beginning after 12/31/98. These determination letters are referred to as GUST II or Full GUST letters.

      HCE Compensation Limit

      The maximum amount of salary that can be considered when testing for Compliance with the 401k plan. If a Highly Compensated Employee's (HCE's) total salary were considered when calculating their withholding percentage, then plans would not fail testing as often as they do.


      Permissive Disaggregation Test: If you fail an initial anti-discrimination test, a PDT is a possible testing option. If you have a plan that allows (part-time employees under 21 who have worked with you less than a year) to join the plan, you can test this group separately. Since this group usually doesn't join a 401k plan, and since there are probably no HCEs in this group, the PDT can help a plan pass that might otherwise have failed.
      There are other sophisticated testing options (like age banding, social security integration, and cross-testing), which illustrates why it is important to have a good Third Party Administrator. Sometimes, you really do get what you pay for.

      Permitted Disparity

      See Social Security Integration below.

      Social Security Integration

      Also known as Permitted Disparity - 401(l) - Employees who make more than the Social Security wage base can be given a larger 401k contribution according to this provision. If the disparity level is uniform, and it begins at a pay rate above the (Social Security taxable wage base), the disparity can be as much as 5.7% higher than the rate given to those below the wage base.
      I'm not making this stuff up! See IRS code 401(l) for more details about SSI logistics and limits

      Simple Contribution Limit

      Ignoring all other variables, this is the maximum amount an employee can contribute to a 401k plan.

      SIMPLE Retirement Plan

      SIMPLE is an acronym that stands for Savings Incentive Match PLan for Employees. The limits are about 30% lower than a 401k, the rules are less complicated, and there is no annual 5500 filing requirement. Employers are required to make a 3% match or a 2% Non-Elective Contribution. All deferrals and contributions are 100% vested. Pretty simple, huh?

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    Professionals in the Pension Industry have an acronym for almost everything, and more are being created every day.


      Average Contribution Percentage


      Average Deferral Percentage


      Certified Employee Benefit Specialist


      Chartered Market Technician


      Certified Public Accountant


      Certified Valuation Analyst


      Defined Benefit


      Defined Contribution


      Equivalent Benefit Accrual Rate


      Economic Growth and Tax Relief Reconciliation Act of 2001


      Employee Retirement Income Security Act


      Federal Insurance Contributions Act


      Federal Income Tax


      Highly Compensated Employee


      Combined ESOP and 401(k) Plan


      Non-Highly Compensated Employee


      Investment Analyst


      Non-Elective Contribution


      Qualified Automatic Contribution Arrangement


      Qualified Default Investment Alternative


      Qualified Joint and Survivor Annuity


      Permissive Disaggregation Test


      Qualified Non-Elective Contribution


      Qualified Pension Analyst


      Small Business Job Protection Act (of 1996)


      Safe Harbor Non-Elective Contribution


      Simplified Employee Pension


      Savings Incentive Match PLan for Employees


      Summary Plan Description


      Third Party Administrator


      Tax Sheltered Annuity

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    ADP / ACP Testing - The Two Primary 'Anti-discrimination' tests for Non-Safe Harbor Plans

    All 401k plans are required to undergo a series of annual tests. The type of tests required for your plan will depend partly on the benefits provided, as well as the features and options outlined in your plan document.

    Some tests involve making sure simple limits are not exceeded. Other tests are designed to ensure that (Officers, Directors, Key Employees, etc.) don't receive a majority of the benefits available in the plan. These tests are referred to as Anti-discrimination tests.
    Officers, Directors, and Key employees are referred to as HCEs. Congress defines an HCE as anyone who makes more than $105,000 in 2008 - Please refer to the Statutory Limits Table for more details about annual HCE limits.

    Anti-discrimination tests attempt to make 401k plans more equitable by placing restrictions on how much an HCE can participate in the plan. These restrictions are generally based on how much non-HCEs are participating in the plan, or on the level of 401k benefits provided to non-HCEs.

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    Other Tests Required for Many 401k Plans

    This course will provide a summary explanation of the following tests:
    • Coverage test
    • Gateway Minimum test
      More detailed procedures (for the coverage and gateway minimum tests) are provided in separate courses.
    And it will provide instructions on how to perform the:
    • Top Heavy test
    • Maximum Deferral Limit test
    • Annual Limitations Test
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    The Coverage Test (IRC §410(b))

    The Coverage Test is another anti-discrimination test. This one is designed to ensure that a 401k plan is offered to most of your employees, not just HCEs. This test applies to many qualified benefit plans - not just retirement plans. The coverage test can become an issue if your company segregates employees into groups, then limits benefits to some of those groups.
    The coverage test may also become an issue if you have a temporary work-force that could be considered statutory employees.

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    Earn Continuing Education Credit!

    All our course material is available Free of Charge to Subscribers fo 401ktest.com!

    You can can also get CPE Credit for these courses by visiting CPEcredit.com. They sell our courses online, and they currently have the following courses available:
    • 401k - A Basic Guide - 3 hours of CPE in most states
    • ADP / ACP testing - 2 hours
    • Other Tests Required for many 401k plans - 2 hours
        This course includes detailed instructions on how to perform the:
        • Top Heavy test
        • Maximum Deferral Limit test
        • Annual Limitations Test
    We also released the following course for our friends in the non-profit community:
    • 403b - A Basic Guide - 3 hours of CPE

    We chose CPEcredit.com as our courseware publisher because
  • their site is very easy to navigate,
  • their courseware architecture is superior to many others, and
  • they were willing to offer our content at a low price.
    We are very aware that this material is offered for $1,000s elseware; but we are committed to providing affordable 401k services to the small business community.

    Future topics for consideration include:
    Cafeteria Plan Basics
    Cross-testing and EBAR techniques
    We are soliciting subject matter experts for these topics. Please contact us at info@401ktest.com if you would like to be considered. Please include a resume and/or a sample of your work. We're looking for writers who can present complicated topics in an understandable way.

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