401(k) Frequently Asked Questions

You may have questions regarding 401(k) plans. We have compiled a list of frequently asked questions in order to help you understand them.

What is a 401(k) plan?

A 401(k) plan is a cash or deferred arrangement that lets an employee contribute part of their pretax compensation instead of receiving that compensation in cash. A 401(k) plan is an employer-sponsored qualified retirement plan.

What are the tax advantages of a 401(k) plan?

For your employees, elective deferrals are not taxed until they are distributed to the employee (FICA and FUTA taxation may apply). Pretax deferrals also reduce the employee’s compensation for income taxes. As an employer, you get a deduction for employer contributions made to the plan.

Can you sponsor a 401(k) plan?

If you are a partnership, limited liability corporation, tax-exempt organization or corporation, you can sponsor a 401(k) plan. If you are self-employed, you may have a 401(k) plan, but your contribution must come from the pretax net earnings of your business.

How do you start a 401(k) plan?

You must have a written plan document. Most plan documents are obtained from attorneys or third-party administrators.

When can your employees start contributing to the 401(k) plan?

Subject to IRS rules, you can set the eligibility requirements for your plan. However, your employees must be allowed to participate if they are age 21 and have at least one year of service (1,000 hours).

When is the last day to make a contribution?

Employees can make elective deferrals until the end of the tax year, but only on compensation they have not yet received. You can make employer contributions until the due date of your business’ tax return (plus extensions).

What are elective deferrals?

Elective deferrals are contributions made by an employer after receiving an employee’s cash or deferred election. Some 401(k) plans have an automatic enrollment. Automatic enrollment assigns a deferral percentage to the employee unless the employee opts out of participation in the plan. Make sure you allow your employees to make or change their deferral percentage at least once a year.

What are elective deferrals?

What is a designated Roth account?

Roth contributions are taxed when they are made, but its qualified distributions are tax-free. If you allow Roth contributions, you must keep them in a separate Roth account. The effective deferral limit for Roth contributions is the same as for pretax contributions.

Is there a maximum limit for elective deferrals?

For 2022, the maximum limit for elective deferrals is $20,500. The limit applies to the individual employee, even if they move to a different employer during the year. Any contributions you make as an employer are not included. If an employee is age 50 or older by the end of the year, they can make an additional $6,500 catch-up contribution.

What if an employee goes over the maximum deferral limit?

If your employee goes over the deferral limit, they are taxed on the excess amount. However, if your plan permits, they can remove the excess amount from the plan. If they withdraw by April 15 of the following year, it is treated as a corrective distribution and not included in the employee’s gross income. However, any earnings in the account because of the excess amount are taxed.

What are matching contributions?

A matching contribution is a contribution you make to the plan. You can choose the amount or percentage of elective deferrals you will match. For example, you can contribute 50 cents for each dollar an employee defers. However, you are not required to make matching contributions. If you do, the contributions may be tax deductible.

Is there a maximum contribution limit?

For 2022, the combined employer contributions and elective deferrals are limited to the lesser of $61,000 or 100% of a participant’s compensation.

What does “compensation” mean?

Within IRS restrictions, you can define what compensation is for your plan. Compensation may include wages, salaries, bonuses, self-employment income, taxable income from employer-provided accident and health insurance benefits and medical reimbursement plan benefits, employer-paid nondeductible moving expenses and the value of certain stock option grants included in income.

What is your maximum employer deduction for employer contributions?

Your deduction for employer contributions is limited to 25% of all participants’ compensation. In 2022, compensation is limited to $305,000 per participating employee.

What if you go over the deduction limit?

If you go over the deduction limit, you must pay a 10% excise tax on the nondeductible amount. However, you can deduct any excess amount in a succeeding taxable year if you do not go over the deduction limit in that year.

When can employees receive distributions?

Generally, distributions cannot be made until the employee retires, dies, becomes disabled or leaves employment. However, you can allow for in-service distributions of some contributions when your employee reaches a certain age and experiences a qualified event such as an illness. In-service distributions are taxed as ordinary income to the employee. Work with your plan adviser if you want to allow in-service distributions.

When must distributions be made from a 401(k) plan?

A 401(k) plan must comply with the required minimum distribution (RMD) rules. RMDs are minimum amounts that must be withdrawn from an individual retirement account (IRA) or retirement plan account each year after reaching age 72 (or after reaching 70 ½ if 70 ½ before January 1, 2020). For workplace retirement plans, individuals can delay taking RMDs if they continue working and are not a 5% owner of the company.

What is a hardship distribution?

You may allow employees to take a hardship withdrawal from their account. The distribution is allowed if it is made because of an immediate and heavy financial need and the distribution is necessary to meet that need. The amount of the hardship withdrawal cannot exceed the participant’s total elective contributions as of the withdrawal date reduced by any prior amounts of hardship distributions.

How are distributions taxed?

Distributions are taxed as ordinary income and reported on Form 1099-R.

Can an employee take a loan from the 401(k)?

You may allow employees to take a loan from their account. You can also place limits on loan availability and amount. Generally, the loan must be repaid within five years. If you allow for loans, work with your adviser to draft a loan policy that meets IRS requirements.

A 401(k) plan is one of the most popular employer-offered benefits. If you have more questions or want to find out if a 401(k) plan is right for your business, talk to your benefits adviser.

For more answers please visit the IRS website, and call or email your JAISIN insurance advisor to learn more about business insurance coverage.