401(k) Plan FAQs

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401(k) FAQs

What type of investments are allowed under a 401(k) and/or Profit-Sharing Plan?

Most any investment is allowed in a retirement plan. For example, stocks, bonds, mutual funds, CDs, Mortgage Notes, Real Estate Investment Transactions (REITs), unimproved land, improved land, certain limited partnerships (see below), and even art & other collectibles are acceptable.  The one major exception is that you cannot use the investments for your own personal use.

What type of business entity can sponsor a retirement plan and claim deductions?

A plan can be sponsored by any type of business entity (including most non-profit organizations) whether or not incorporated. This may include Sole Proprietorships, Partnerships, Limited Liability Company, S-corporations, C-Corporations, and professional corporations. Contributions calculated within IRS prescribed limitations are 100% deductible.

Which employees must be covered under the plan and does that include leased employees?

Generally, any employee working for 1 year and at least 20 hours a week is eligible for the plan.

How is the employer contribution determined and allocated?

It depends on how the employer wants the plan designed.  If 401(k) deferrals are involved, the contribution can be in the form of Matching and Profit Sharing.  Those contributions are usually divided up based on a percentage of salary.

Can an Owner/Highly Compensated Employee always make the maximum employee 401(k) Salary Deferral mentioned in the previous question?

No. Certain limits apply based on what rank and file employees defer/contribute.

Is there a way around the ADP test, which ties the Owner/Highly Compensated Employee ability to make salary deferrals to what salary the employees are deferring?

Yes. Referred to as Safe Harbor contributions, the employer can make certain guaranteed contributions, and the IRS will allow Owners/Highly Compensated Employees the ability to maximize deferrals regardless of rank and file participation. Safe Harbor contributions can be in the form of a matching contribution or a qualified non-elective contribution (QNEC).

What is a “Cross-tested” (also known as “New Comparability”) Profit Sharing Plan and why have they become so popular in recent years?

The Cross-Tested Profit-Sharing Plan allows contribution levels to be different for each participant.  With the right employee demographics, larger contributions can be made to the owners/highly compensated employees.

When does the contribution have to be made?

The contribution must be made by the due date of your tax return, that reflects the tax deduction (including any extension).

Are the benefits under the plan guaranteed?

No.  Only certain Defined Benefit Plans have any benefits guaranteed.

Can I terminate the 401(k) plan and when can I do so?

Yes, a plan can usually be terminated at any time. 

What are the available vesting schedules?

Most common are shown below:

“2-20” Schedule

  •  0-1 Year = 0%
  • 2 Years = 20%
  • 3 Years = 40%
  • 4 Years = 60%
  • 5 Years = 80%
  • 6 Years = 100%

“3-Year Cliff Schedule”

  • 0-2 Years = 0%
  • 3 + Years = 100%

Note: An employee is always 100% vested in their own 401(k) salary deferrals.

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