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 If you're thinking about contributing to your employer's 401k plan, but need more information, we've got most of the 401k rules covered in this article. We use the word "most" because 401k plans are tricky in that employers have some flexibility in how they can administer their plan.
As a matter of fact, there is simply no one other than your plan administrator that can give you all of the 401k rules that apply to your situation. However we can provide you with the general rules that will apply to anyone that participates in these plans at work.
401k Eligibility Rules
A 401k plan is simply a tax-deferred compensation plan that is structured to supply employees with income when retired. That mean an employee can elect to contribute a portion of their compensation into this retirement plan on a pre-tax basis. Since this is tax-deferred compensation, a 401k can act as a tax shelter. Money placed into a 401k plan can continue to grow on a tax-deferred basis until the money is withdrawn.
There are only a couple of eligibility rules that may apply to certain workers:
- Employees that have not reached the age of 21 may not be eligible.
- Employees may be required to complete a year of service before participating in the plan.
- Employees covered by a collective bargaining agreement may have discussed retirement benefits during negotiations, and they may have reached agreement not to participate in the 401k plan as part of that good-faith bargaining.
To set up a 401k plan, your employer only needs to comply with four requirements:
- The plan must be in writing.
- The plans assets must be in a trust fund.
- They need to have a recordkeeping database.
- Information needs to be provided to employees.
The employer can determine the exact rules of eligibility; however, the IRS has provided the owners, or highly-compensated employees, of a company with an added incentive to make sure participation is high among all employees.
Matching Employee Contributions
Each year, the 401k plan must pass a test the IRS has put together to make sure the benefits of this plan are proportional between the owners and the rank-and-file employees. If not enough of the rank and file employees participate in the plan, then no one gets to participate in the plan.
This is one of the reasons that many employers have adopted the approach of matching employee contributions. By matching the contributions of employees, the plan provides an instant return on investment. This is simply too irresistible to many employees, and the resulting robust participation relieves the employer's concern over the annual test conducted by the IRS.
401k Contribution Rules
In 2007 and 2008, the total of both the employer and employee contributions to a 401k plan are subject to the following contribution rules:
- Total contributions may not exceed 100% of the employee's compensation.
- Total contributions may not exceed $45,000 in 2007, and $46,000 in 2008.
- In 2009 and later years, total contributions will be indexed to inflation and can move up in $1,000 increments.
Employees are further subject these additional contribution rules:
- In 2007, the total contribution that an employee can make on a pre-tax basis is limited to $15,500. This limit remains the same in 2008.
- In 2009, the total contribution that an employee can make will be calculated using an index for inflation and can move up in $500 increments.
Catch-Up Contribution Rules
This final set of contribution rules applies to employees that are aged 50 and over. The IRS allows for additional catch-up contributions to 401k plans. In 2007, the catch up contribution was $5,000, and in 2008 the catch up contribution is also $5,000. This means that in 2008 an employee aged 50 and over before the end of the calendar year can contribute up to $20,500 ($15,500 + $5,000) to their 401k plan on a pre-tax basis. In 2009, that total will likely rise to levels above $20,500.
401k Vesting Rules
When an employee makes a salary deferral, the money placed in the 401k plan is immediately 100% vested. This means the money always belongs to the employee and cannot be forfeited for any reason. This also means that when an employee leaves a company, they are entitled to the total of any money they placed into the plan plus any gain on the investment, or minus any loss.
With a traditional 401k plan it is up to the employer to decide how the employer contributions, if any, are vested. This vesting schedule will be part of the written documentation supplied to the IRS. You should consult with your 401k plan administrator if you have any questions concerning the vesting rules that apply in your situation.
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