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Different types of 401(k)’s

If the numbers and your own experiences cause you to ponder the benefits of a retirement plan, you may be considering a 401(k) plan. They come in several varieties, and figuring out which flavor is right for your business can be a bit confusing. Before you speak with your accountant or financial advisor about the plan that meets your needs, this description of the current plans available may help.

Solo 401(k)—A regular 401(k) plan combined with a profit-sharing plan, a solo 401(k) plan (also called a single participant 401(k) plan) can be implemented only by self-employed individuals or small business owners who have no other full-time employees (with the one exception applying if your full-time employee is your spouse). If you have full-time employees age 21 or older (other than your spouse) or part-time employees who work more than 1,000 hours a year, you will typically have to include them in any plan you set up, you won't be able to implement a solo 401(k). A solo 401(k) plan isn't really a different kind of 401(k) plan, but one that simply takes advantage of the fact that normal discrimination tests aren't required when the only individuals who participate in the plan are the owner (and the owner's spouse).
Safe harbor 401(k)—Like other 401(k) plans, safe harbor plans are available for employers of any size and can be combined with other retirement plans. However safe harbor plans differ in that they require employer contributions that are fully vested when they're made. The contributions can be employer matching, limited to employees who defer or employer contributions made on behalf of all eligible employees, regardless of whether they make elective deferrals. Also, both Safe Harbor 401(k)s now allow Roth type contributions, which can allow highly compensated employees (currently shut out of Roth IRAs) to accumulate deposits that could be available income tax free at retirement. In addition, safe harbor plans aren't subject to many of the complex tax rules associated with traditional 401(k) plans, including the annual testing mentioned above. Safe harbor 401(k) plans that don't provide any additional contributions in a year are exempted from the "Top Heavy Plan" rules in section 416 of the Internal Revenue Code. If you do offer a safe harbor plan, you'll be required to satisfy certain notice requirements regarding employees' rights and requirements under the plan, methods used and summary plan description. Finally, you may be able to maximize your own contributions to the plan regardless of what your employees are doing, which makes setting up these plans easier, compared to 401(k) plans without the safe harbor contributions provisions.
Traditional 401(k)—The traditional offers the most flexibility. As an employer, you have the choice of making contributions on behalf of your employees (those eligible to participate), matching their deferrals or doing both. A traditional 401(k) allows participants to make pre-tax contributions through payroll deductions. Like Safe Harbor 401(k)s, traditional 401(k) plans also allow Roth type contributions from highly compensated employees. There are certain rules regarding traditional 401(k) contributions under which an employer must perform annual tests—known as the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests—to verify that deferred wages and employer matching contributions do not discriminate in favor of highly compensated employees.
SIMPLE 401(k)—More streamlined and small-business friendly than traditional 401(k) plans, SIMPLE 401(k) plans aren't subject to any of the annual tests. Like safe harbor plans, the employer is required to make employer contributions that are fully vested when made. The SIMPLE 401(k) is available to employers with 100 or fewer employees who received at least $5,000 in compensation from the employer for the previous calendar year. Unlike traditional or safe harbor plans, employees covered under SIMPLE 401(k) plans can't receive any contributions or benefit accruals under any other plans offered by the employer.

Another overall benefit of starting any retirement plan is that the government offers credit for startup costs of any qualified plan. The credit equals 50% of the cost to set up and administer the plan and educate employees about the plan, up to a maximum of $500 per year for each of the first three years of the plan. And, with the exception of Solo 401(k) plans, you can choose to start claiming the credit in the tax year before the tax year in which the plan becomes effective.

To learn more about these plans, read the IRS's 401(k) Resource Guide. Talk with your accountant or financial planner before making any plan decision.

*The information and content provided is general in nature and is for informational purposes only. Such information is provided as a convenience to you, and Woody Wood and Realnet Co’s makes no warranties and bears no liability for your use of this information. Woody Wood and Realnet Co’s does not endorse and is not responsible for the content, The information made available to you is not intended, and should not be construed as legal, tax, or investment advice, or a legal opinion. You should contact your legal, tax and/or financial advisors to help answer questions about you and your business' specific situation or needs prior to taking any action based upon this information.

Different Types of 401 (k)s

4 different types