Retirement plan professionals often focus on the complexities of 401(k) plans and geek out when new regulations are released, perhaps overlooking the needs of a generation of employees entering the benefits field who likely have not experienced the behind-the-scenes fun of 401(k) plan operation. In addition to benefits professionals, educating payroll and human resource employees with basic principles of plan operation is critical to 401(k) plan compliance. Perfect time to get back to basics.

Ever wonder what a good introduction to someone hired into a benefits position who has no knowledge of 401(k) plans would be? You would not be alone. We dedicate much of our time working directly with plan fiduciaries and investment committees but often do not focus enough on the behind-the-scenes benefits professionals who are integral to the daily operation of a company’s 401(k) plan.

If this writing were a college course, it would aptly be called 401(k) Plans 101 - The fundamental concepts of 401(k) plans: legal plan documents that govern the plan; eligibility and participation requirements; contribution sources available in the plan; and timing requirements for payroll deposits into the plan. Upon completing this course, 401(k) newbies will have a basic understanding of 401(k) plans and will know where to turn for information beyond the basics.

What is a 401(k) Plan?

A 401(k) plan (or 403(b) plan for those employed by non-profit entities) is simply a retirement plan that is sponsored by an employer that allows employees to elect to have some of their current income deposited into a trust to save towards retirement. Internal Revenue Code Section 401(k) is one of the few code sections that Americans know by name. Specifically, these are cash or deferred arrangements under which an employee may elect to have the employer make payments to the trust on behalf of the employee. The employee has the option to take the cash on their pay date or to make a contribution, known as a salary deferral, to the retirement plan.

The employees’ contributions are held in a retirement plan trust which provides certain tax benefits as long as the amounts contributed on the employees’ behalf remain in the trust. The purpose of a 401(k) plan is to save toward retirement and to accumulate tax deferred savings over one’s working years. Because the trust provides tax benefits to the employee, the amounts held in the plan may not be distributed until normal retirement age. However, there are exceptions to taking premature distributions from the plan upon certain events (e.g., death, disability, termination of employment, and upon a financial hardship), but the employee will pay taxes on any premature withdrawals from the plan.

401(k) Plan Documents

All 401(k) plans are different, as they are generally designed to meet the specific needs of the employer’s covered employees. There are boundless options available when designing a 401(k) plan, so one employer’s plan will not be the exact same as another employer’s plan. The rules and regulations that govern 401(k) plans are the same, but the plans themselves will contain different provisions.

An employer’s 401(k) plan is required to be in writing and is required to be signed by the employer. The plan provisions specific to that employer are contained in the legal plan documents, which must be followed to maintain the operational compliance of the plan and to maintain the tax deferred status of the trust assets.

The vast majority of 401(k) plans are drafted on Internal Revenue Service (IRS) pre-approved plan documents that are prepared by the plan’s third-party service provider for adoption by the employer. The plan document typically includes two parts – an adoption agreement and a basic plan document. The adoption agreement looks like a menu with options that can be checked off if applicable to that employer’s plan. The basic plan document is much longer and contains all of the details and regulatory requirements, in other words the “how to” piece that correlates to the adoption agreement selections.

Legal plan documents must be updated as laws and regulations change. Currently, pre-approved plan documents must be updated every six years to incorporate changes in the regulations. Those updates are required by law and a failure to update the plan documents can jeopardize the tax qualified status of the trust. Employers may also amend certain provisions in their 401(k) plan, on a discretionary basis and from time to time, as long as the amendment is in writing and signed by the employer.

Note: Plan documents must be maintained for the life of the retirement plan. Plan documents provide a historical record of the provisions in effect at any given time and should always be kept in the employer’s permanent records.

Summary Plan Description

A Summary Plan Description (SPD) is an essential document that must be written in an easily digestible format that helps participants covered by an employer sponsored plan understand how the plan works, what benefits they are entitled to, and their rights and responsibilities under the plan. The SPD outlines the key features, terms, and conditions of the plan and is required by the Employee Retirement Income Security Act (ERISA) to be provided by employers to their employees covered under the 401(k) plan. The contents of the SPD are derived directly from the provisions in the plan’s legal document.

Key elements included in the SPD for a 401(k) plan are:

• Eligibility: Information on who can participate in the 401(k) plan, including any age or service requirements.

• Contributions: Details about employee and employer contributions, including matching contributions, deferral limits, and how contributions are made (e.g., pre-tax or Roth).

• Vesting: Information about the vesting schedule, which outlines how long employees need to work at the company before they fully own employer contributions.

• Investment Options: A list of available investment choices, such as mutual funds, and the process of selecting and changing investments.

• Withdrawals and Distributions: Information on how and when participants can access their 401(k) funds, such as in cases of retirement, termination, or hardship withdrawals.

• Participant Loans: Explanation of whether loans are available from the plan and under what circumstances participants can take loans from their account, if the plan allows loans.

• Plan Administration: Details about how the plan is managed, including the roles of the plan administrator and other key parties.

• Participant Rights: Information on the rights of plan participants under ERISA, including how to file claims, appeal denials, and seek assistance if there are issues with the plan.

The SPD is an essential document that ensures transparency and compliance with federal regulations, helping employees make informed decisions regarding their retirement savings. The SPD must be provided to employees within 90 days of becoming eligible to participate in the plan.

Note: The SPD should not be relied upon for plan operation, as the timing of the required updates to the SPD is later than the effective dates of plan amendments. The plan document and any amendments to the latest version are always the authority for how the plan is operated.

Eligibility and Participation

Before an employee can make salary deferrals into a 401(k) Plan, they must be a covered employee and meet any age or service requirements specific to that plan. A covered employee is one whose employment class is not excluded by the plan terms (e.g., interns), meaning that they must be an eligible employee.

Smaller employers typically require an employee to attain age 21 and complete 12 months of service with the employer to be eligible for the 401(k) plan, while large employers may permit employees to participate in the plan immediately upon an employee’s date of hire. The second step is an employee’s entry date, defined by the plan terms, which could be immediate, on the first day of the next month, quarterly or semi-annually.

Once an employee has met both the age and service requirements and they are employed on the next entry date, then they have officially become a participant in the plan.

Salary Deferral Elections

There are two types of salary deferral elections, affirmative elections and default elections for plans that include automatic enrollment provisions.

• Affirmative Elections – In 401(k) plans that do not include automatic enrollment provisions, eligible participants must make an affirmative deferral election, either on paper or electronically, to state the amount (percentage or dollar) that should be taken from their future compensation. “Future” is key here, as deferral elections cannot be made on a retroactive basis. If, after being provided with the option to defer, an eligible employee does not make a deferral election, then the election is zero.

• Automatic Enrollment – Many 401(k) plans are now required to include an automatic contribution arrangement under which the eligible participant will have deferrals withheld from their compensation upon becoming an eligible participant in the plan unless they opt out or elect a different amount.

One of the most important aspects of operating a 401(k) plan is ensuring that deferral elections are applied correctly to employees’ compensation. Missed deferral opportunities are one of the most common mistakes made in plan operation and compliance requires coordination with the payroll team or payroll provider and the plan’s service providers.

Types of Deferrals

In addition to electing the amount to defer into the 401(k) plan, eligible participants must designate whether to have the deferrals be deducted from compensation on a pre-tax basis or a Roth basis (if the plan includes Roth provisions).

• Pre-Tax deferrals – As the name indicates, pre-tax deferrals are deducted from an employee’s compensation before the application of federal and state income taxes. A pre-tax deferral reduces the employee’s current taxable income but does not reduce the amount of required payroll taxes for Social Security and Medicare (FICA) and Unemployment (FUTA). Upon distribution in retirement, pre-tax deferrals are taxed as ordinary income.

• Roth deferrals – If a 401(k) plan includes Roth provisions, employees may elect to have deferrals deducted on an after-tax basis and treated as designated Roth deferrals. Roth deferrals do not reduce the employee’s current taxable income and do not affect the deductions for FICA or FUTA. Unlike pre-tax deferrals, Roth contributions are not taxed upon distribution in retirement.

It is important to understand the tax treatment differences between pre-tax and Roth deferrals, and to know that these amounts must be separately accounted for in the participant’s 401(k) plan account. From an operational standpoint, there should be oversight to ensure that pre-tax and Roth deferrals are deducted correctly (impacts the Form W2) and deposited to the correct source (pre-tax or Roth) within the plan.

Types of Contributions (Sources)

Contributions to a 401(k) plan are broken down by type, depending on whether the contributions are made by the employee or the employer. Contributions made by an employee are always 100% vested, meaning that the employee fully owns all monies deposited to those sources. On the other hand, employer contributions may be subject to a vesting schedule, requiring an employee to complete a certain number of years with the employer to fully own the contributions in those sources. The most common sources (or “buckets”) in 401(k) plans can be broken down as follows:

• Employee Deferrals – As noted above, deferrals may be either pre-tax or Roth and must be segregated into different “buckets” because of the different tax treatment.

• Employee Voluntary After-Tax Contributions – Often confused with Roth deferrals, after-tax voluntary contributions are NOT deferrals. Yes, these contributions are deducted from an employee’s paycheck on an after-tax basis, but they are not treated the same as Roth deferrals. After-Tax contributions are treated very differently from Roth deferrals. Many plans do not even offer the ability to make this type of contribution, so the plan provisions will determine if they are permitted.

• Employee Rollovers – As employees change jobs, they are permitted to take their vested 401(k) accounts with them and to request that the 401(k) account from the old employer’s plan be directly transferred to the new employer’s 401(k) plan in the form of a direct rollover.

• Employer Matching Contributions – An employer makes matching contributions to incentivize and reward employees for making deferrals to the plan. The match is usually expressed as a percentage of the employee deferrals up to a percentage of total compensation. For example, employee deferrals will be matched at 50% on deferrals up to 6% of eligible compensation. If the employee defers at least 6%, the company match would be 3% of eligible compensation. Note that separate calculations are not applied to pre-tax and Roth deferrals, rather the total deferrals are used to determine the match.
  
  Example: An employee elects to defer 5% as pre-tax deferrals and 2% as Roth deferrals. Using the formula from above, the total deferrals are 7% (5% + 2%) and the employer match would be 3% of the employee’s eligible compensation.
  
  Matching contributions may be subject to a vesting schedule.

• Employer Profit Sharing Contributions – Profit sharing contributions are sometimes referred to as non-elective contributions. Employers have the discretion to make profit sharing contributions which are allocated to participants based on the plan provisions. This type of contribution cannot be contingent on the employee making deferrals to the plan.

• Employer Safe Harbor 401(k) Contributions – Some 401(k) plans are designed as Safe Harbor 401(k) Plans with a required employer contribution and an accelerated vesting schedule. Safe harbor contributions have the same distribution restrictions as employee deferrals and must be separately tracked in the plan.

Note: Employee after-tax contributions are always deducted after deferrals (pre-tax or Roth). There is a precedence or order of deductions that apply to an employee’s gross pay. A common payroll error is taking the deductions out of order or prorating across deductions which may cause operational errors and erroneous deductions if there is not sufficient gross pay to fully apply all of the required and voluntary deductions.

Timing of Employee Contributions

Employee contributions include employee deferrals (pre-tax and Roth), voluntary employee contributions (after-tax contributions) and employee loan repayments. These payroll deductions are required to be deposited to the 401(k) plan as soon as reasonably possible because those funds are considered plan assets.

As a best practice, employee contributions should be remitted to the plan on the same day that the paychecks to the employees are issued. If the employer’s payroll department cannot deposit employee contributions the same day as payroll because of administrative or system limitations, then employee contributions should be submitted within a three-business day industry standard in most cases.

Failure to timely remit the employee contributions to the trust results in late employee contributions that must be corrected under the Department of Labor’s Voluntary Fiduciary Correction Program (recently updated effective March 17, 2025).

Note: Late deferrals and missed deferrals are often confused. The distinction is that a missed deferral occurs when the deduction is not taken from the employee’s paycheck, while a late deferral occurs when the deduction is taken but not deposited to the plan timely.

Conclusion

A basic understanding of 401(k) plans is useful for all parties that have some oversight or responsibility related to the operation of the employer’s 401(k) plan. Every plan is unique and the first “go to” resource when there are operational questions is the plan’s legal document. Also rely on your plan’s service providers to guide your team through the more complex issues.

If you came away with more of a basic understanding than you started with, then congratulations – you passed 401(k) Plans 101!

Newfront Retirement Services’ team of advisors and dedicated service team are always available to help iron out the more complicated details of plan operation. Feel free to contact me or just connect to keep up to date on all things ERISA 401(k): Joni_LinkedIn and 401(k)ology

Helpful Links:

• 401(k)ology – Missed Deferral Opportunities

• 401(k)ology – Late Employee Contributions

• 401(k)ology – Safe Harbor 401(k) Plans

• Retirement topics – Automatic Enrollment

• Voluntary Fiduciary Correction Program

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