There are three basic types of 401(k) retirement plans that an employer may choose from: a traditional 401(k) plan, a safe harbor 401(k) plan, or a SIMPLE 401(k) plan.
Traditional 401(k) Plan
One of the major advantages of a traditional plan is its flexibility. As a matter of fact, it is the most flexible type of 401(k) plan. An employer who adopts a traditional plan has the option of making contributions on behalf of all participants, of matching the participants' deferrals, or of doing both. In addition, these employer contributions can be subject to a vesting schedule, which provides that they are forfeited if an employee leaves his or her job before a set period of time. A traditional 401(k) plan allows employees to make pre-tax contributions through payroll deductions.
An employer who adopts a traditional 401(k) plan is required to perform annual testing to ensure that benefits for rank-and-file employees are proportional to the benefits for highly compensated owners/managers. This testing can be complicated.
Safe Harbor 401(k) Plan
Both the traditional and safe harbor plans are available to employers of any size, and they can be combined with other retirement plans. A safe harbor plan is similar to a traditional plan in many respects, but it must provide for employer contributions that are fully vested when made. Thus, any employee who leaves at any time does not forfeit either his own deferrals or contributions made on his behalf by the employer. An employer who chooses to contribute may match an employee's contributions dollar for dollar up to a statutory maximum or he may make a nonelective contribution of a set percentage of the employee's compensation.
One advantage of a safe harbor plan is that it is not subject to many of the complicated tax rules that apply to a traditional plan, included annual testing to determine that the plan does not discriminate in favor of highly compensated employees.
SIMPLE 401(k) Plan
This type of plan was designed with small businesses in mind. It attempts to give small businesses a way to offer retirement benefits to their employees in an effective, cost-efficient manner. An employer is entitled to establish a SIMPLE plan if his business has 100 or fewer employees who received at least $5,000 in compensation from the employer in the prior year. Employees covered by a SIMPLE plan may not receive any contributions or benefit accruals under any other retirement plans of the employer.
Like a safe harbor plan, a SIMPLE plan is not subject to the annual nondiscrimination testing required of a traditional plan. An additional advantage to a SIMPLE plan is that there is a straightforward benefit formula for easy administration. Optional participant loans and hardship withdrawals add flexibility for employees; however, this feature adds some administrative burden to the employer.
Any employer contributions made under a SIMPLE plan fully vest immediately.
Copyright 2010 LexisNexis, a division of Reed Elsevier Inc.
