401(k) plans let you and your employees defer current income into the plan. You can match
your employees’ deferrals make discretionary profit-sharing contributions or both.
These may be your best choice if you want to let your employees fund the bulk of their own accounts:
1. You can defer up to 100% of your “covered compensation” or $19,500, whichever is less. (Covered comp is wages, salary, and bonus up to $290,000.)
2. You can let employees age 50 or older make extra “catch-up” contributions of up to $6,500 not limited by antidiscrimination rules.
3. You can match part or all of employee deferrals and make profit-sharing contributions. These are nontaxable until participants start withdrawing funds from their accounts. The employer’s contributions are tax deductible.
4. Total “annual additions” from employee deferrals (but not catchups), employer matches, and employer profit-sharing contributions are limited to 100% of covered compensation, but not more than $58,000.
5. You can let employees take tax-free loans from their accounts. Most loan provisions allow loans up to $50,000 or 50% of the vested account balance, whichever is less, and repay it in substantially level installments, at least quarterly, over five years. If employees leave their job and take their accounts with outstanding loans, the unpaid balance is taxable unless they repay it from another source.
6. You can let employees take “hardship withdrawals” of their own deferrals (but not employer contributions or earnings) for “immediate and heavy” financial needs: medical bills, a down payment on a house, college costs, or amounts needed to prevent eviction or foreclosure on their primary residence. If the plan allows loans and hardship withdrawals, employees have to take the maximum loan before taking a hardship withdrawal. Employees who take hardship withdrawals can’t make new deferrals for 12 months.
7. Plan withdrawals are taxed as ordinary income. There’s a 10% penalty for withdrawals before age 59½ except for specified exceptions: death, permanent and total disability, health insurance while unemployed, amounts deductible as medical or dental expenses, college costs, early retirement at age 55 or older, or qualified domestic relations orders.
8. Rollovers to another qualified plan or IRA are nontaxable.