There are several types of 401(k) plan designs including:
- Traditional 401(k)
— Allows employees to defer a portion of current income on a tax-deferred basis (after FICA, but before federal and most state taxes). Employer contributions are permitted, but not mandatory.
- Safe Harbor 401(k)
— Though similar in many ways to the traditional 401(k), a Safe Harbor plan differs in several key respects. First, unlike traditional 401(k) plans, a Safe Harbor plan may be exempt from ADP and/or ACP nondiscrimination tests (explained below) provided certain requirements are met. Also, unlike traditional 401(k) plans, employer contributions are required and these contributions are immediately 100 percent vested.
- SIMPLE 401(k)
— A Savings Incentive Match Plan for Employees is a simplified qualified retirement plan for employers with 100 or fewer employees earning at least $5,000 in the prior year. Similar to a Safe Harbor 401(k), a SIMPLE 401(k) plan has no discrimination or top-heavy testing. Employer contributions are immediately 100 percent vested. This plan only allows for employee deferrals and the employer-required contributions.
The 401(k) plan is so popular today that the selection question is more commonly "which type?" than "should I install one for my company?" when it comes to choosing the CODA (cash or deferred arrangement) approach. To better understand these popular plans, let's take a closer look at each.
