What is a 401(k) Plan

A 401(k) plan generally is a profit sharing plan or stock bonus plan that provides for contributions to be made pursuant to a “cash or deferred arrangement” (CODA) under which individual participants elect to take amounts in cash or to have the amounts deferred under the plan. Amounts deferred under this election are excluded from a participant’s gross income for the year of the deferral (in other words, the contributions are made with before-tax dollars) and treated as employer contributions to the plan. Treas. Regs. §§1.401(k)-1(a)(4)(ii), 1.401(k)-1(a)(4)(iii); see also Prop. Treas. Regs. §§1.401(k)-1(a), 1.401(k)-1(f)(1). In addition to the general qualification requirements, special qualification rules apply to 401(k) plans.

A 401(k) plan may provide that all employer contributions are made pursuant to the election (a stand-alone plan) or may provide that the cash or deferred arrangement is in addition to ordinary employer contributions. Typically, the employer contributions are in the form of a percentage match for each dollar deferred by an employee. For the requirements that apply to matching contributions.

Solo 401(k) plans. The term “solo 401(k) plan” generically refers to any 401(k) plan that covers only one participant. While the advantages to a sole proprietor or one-person corporation can be significant, it is important to note that in the event one or more employees are later added to the sponsoring employer, the plan would be subject to the same minimum participation,coverage, nondiscrimination, and other requirements that apply to any other qualified defined contribution plan.

Solo 401(k) plans are a product of qualified plan reforms implemented by EGTRRA 2001, which substantially improved the tax favored treatment for employers sponsoring 401(k) plans. These changes were designed to encourage greater savings for retirement and to provide more incentive to businesses funding 401(k) plans.

Roth 401(k). Beginning in 2006, 401(k) plans will be permitted to offer a “qualified Roth contribution program.” See IRC §402A; for details. Such a plan will allow after-tax elective deferrals to a Roth account, which will operate in a manner similar to Roth IRAs. See IRC §402A.