Traditional 401(k) (Small Business 401(k)) Flashcards
What is a 401(k) plan?
A 401(k) plan is a retirement savings plan sponsored by an employer that allows employees to save and invest for their retirement on a tax-deferred basis.
Who can contribute to a small business 401(k)?
Answer: Employees and employers can contribute to a small business 401(k) plan, with employee contributions being deducted from their paycheck and employer contributions typically being discretionary.
What are the contribution limits for a 401(k) in 2025?
Answer: For 2025, the employee contribution limit is $22,500, with a $7,500 catch-up contribution for those aged 50 or older.
What is a “matching contribution” in a 401(k)?
Answer: A matching contribution is when an employer contributes to an employee’s 401(k) based on the employee’s contributions, often up to a certain percentage of salary.
What is the advantage of a 401(k) plan for small businesses?
Answer: A 401(k) plan can help attract and retain talent, provide tax benefits, and offer employees a way to save for retirement.
What is vesting in a 401(k) plan?
Answer: Vesting refers to the employee’s right to keep the employer’s contributions to their 401(k) plan after a certain period of employment.
What types of 401(k) plans are available for small businesses?
Answer: Options include traditional 401(k), safe harbor 401(k), and SIMPLE 401(k) plans.
What is a safe harbor 401(k) plan?
Answer: A safe harbor 401(k) plan is a type of plan that allows employers to avoid certain annual testing requirements by making mandatory contributions on behalf of employees.
Can self-employed individuals set up a 401(k)?
Answer: Yes, self-employed individuals can set up a Solo 401(k) plan for themselves and their spouse (if applicable).
What are the tax advantages of a 401(k) plan?
Answer: Contributions to a 401(k) plan are made on a pre-tax basis, reducing taxable income, and the investments grow tax-deferred until withdrawal.
How can a small business owner ensure their 401(k) plan complies with both ERISA regulations and the IRS’s non-discrimination testing requirements, particularly in a company with a diverse salary structure?
A small business owner must ensure compliance by regularly conducting non-discrimination testing (e.g., Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests) to avoid favoring highly compensated employees (HCEs). To meet ERISA standards, the plan must offer fair access, prudent investment selection, and proper disclosure. Employers may opt for a Safe Harbor 401(k) plan, which automatically satisfies testing requirements by providing required employer contributions, thus ensuring compliance while minimizing the risk of violations.
- What are the implications of selecting a safe harbor 401(k) plan versus a traditional 401(k) plan for a small business, and how does this decision affect annual testing, employer contribution obligations, and employee participation?
A Safe Harbor 401(k) plan eliminates the need for annual non-discrimination tests by providing mandatory employer contributions (either matching or non-elective) to employees. This simplifies plan administration and ensures broader employee participation. On the other hand, a traditional 401(k) plan may require additional testing, and if the plan fails, the employer may need to make corrective contributions. The employer in a Safe Harbor plan has more predictable contribution obligations, while traditional plans offer more flexibility but require careful testing.
How does a small business 401(k) plan’s fiduciary responsibility impact the employer’s role in selecting plan investments, monitoring performance, and avoiding conflicts of interest?
As a plan fiduciary, the employer must act solely in the best interests of the plan participants, adhering to the “prudent man rule” under ERISA. This means selecting a diverse set of investments, regularly reviewing their performance, and avoiding conflicts of interest. The employer should ensure the fees associated with investments are reasonable and monitor the plan regularly to ensure it meets the needs of participants. To mitigate personal liability, many small businesses outsource fiduciary responsibilities to third-party administrators or hire fiduciary advisors.
What are the potential tax benefits for small business owners and employees when utilizing a profit-sharing component alongside a 401(k) plan, and how does this impact contribution limits and deductibility?
Adding a profit-sharing component to a 401(k) plan allows the employer to contribute a percentage of the business’s profits to employees’ accounts, which is deductible as a business expense. For employees, this provides additional retirement savings on top of their regular 401(k) contributions. The combined total (employee deferral plus profit-sharing contributions) cannot exceed the annual limit of $66,000 in 2025 (or $73,500 for employees over 50). Profit-sharing offers flexibility in contribution amounts, as the employer can adjust contributions based on business performance.
How do contribution limits for a small business 401(k) plan differ based on whether the employer sponsors a SIMPLE 401(k) or a traditional 401(k), and what are the advantages and disadvantages of each for both employers and employees?
Answer: A SIMPLE 401(k) plan has lower contribution limits than a traditional 401(k). In 2025, employees can contribute up to $15,500 ($19,000 for those 50 and older) to a SIMPLE plan, while the limit for a traditional 401(k) is $22,500 ($30,000 for those 50 and older). The employer must match contributions up to 3% of the employee’s salary or make a 2% non-elective contribution. While SIMPLE plans are easier to administer and less expensive, they offer less flexibility in terms of employer contributions. Traditional 401(k) plans have higher contribution limits and more flexibility, but they require more complex administration.
In a small business with a mix of part-time and full-time employees, what strategies can the business owner use to ensure equitable participation and benefit accumulation in the 401(k) plan while avoiding penalties for discrimination?
To avoid discrimination penalties, the employer should ensure that both full-time and part-time employees have equal access to the 401(k) plan, provided they meet any eligibility requirements. One strategy is to set up automatic enrollment to increase participation among part-time employees. Additionally, using a Safe Harbor 401(k) plan can help avoid discrimination issues by providing mandatory employer contributions that benefit all employees equally.
How does the “top-heavy” test affect a small business 401(k) plan, and what steps can a business owner take to avoid top-heavy status and its associated consequences?
The top-heavy test determines if more than 60% of a 401(k) plan’s assets are held by key employees (e.g., owners, officers, and highly compensated employees). If the plan is top-heavy, the employer is required to make a minimum contribution (usually 3%) to the accounts of non-key employees. To avoid top-heavy status, the employer can limit contributions to key employees or use a Safe Harbor 401(k) plan, which automatically avoids top-heavy rules.
What are the legal and operational risks for small businesses that fail to properly administer their 401(k) plan, particularly in light of recent IRS and Department of Labor audits, and how can these risks be mitigated through diligent record-keeping and plan review?
Failure to properly administer a 401(k) plan can result in penalties, audits, and disqualification of the plan’s tax-deferred status, leading to tax liabilities for both the employer and employees. Risks can be mitigated by maintaining accurate records of contributions, distributions, and employee eligibility. Regular plan reviews and using third-party administrators can also ensure compliance with ERISA and IRS regulations.
How does the integration of automatic enrollment and automatic escalation features in a 401(k) plan help improve employee participation and retirement savings, and what legal requirements or limitations should a small business owner be aware of when implementing these features?
Automatic enrollment increases employee participation by enrolling them in the 401(k) plan automatically, while automatic escalation gradually increases employee contributions over time. These features improve retirement savings rates and encourage long-term financial planning. However, small businesses must adhere to specific legal requirements, such as providing employees with notice of their enrollment and the ability to opt out, and setting default contribution rates that comply with IRS guidelines.
What is the potential impact of a 401(k) plan on the overall financial health of a small business, particularly in terms of cash flow management, employee retention, and long-term financial goals for the business owner?
A 401(k) plan may initially increase the business’s expenses due to employer contributions, administrative fees, and potential fiduciary responsibilities. However, it can also help attract and retain talented employees, improve employee satisfaction, and enhance productivity. Over time, the plan may contribute to long-term financial goals by offering tax deductions on contributions, reducing the tax burden for the business owner, and fostering employee loyalty.
How does the decision to offer a Roth 401(k) option within a small business 401(k) plan influence the retirement planning strategies of employees, particularly in relation to tax diversification and future income planning?
Offering a Roth 401(k) allows employees to contribute after-tax dollars, which means withdrawals in retirement are tax-free. This provides employees with tax diversification, enabling them to balance the tax treatment of their retirement savings. Employees who expect to be in a higher tax bracket in retirement may benefit from contributing to a Roth 401(k), while those who expect to be in a lower tax bracket may prefer traditional 401(k) contributions.
What are the considerations a small business should take into account when selecting a third-party administrator (TPA) for their 401(k) plan, and how does the TPA’s role affect compliance, reporting, and customer service for the business and its employees?
When selecting a TPA, a small business should consider the TPA’s reputation, experience, fees, and ability to ensure compliance with IRS and ERISA regulations. The TPA is responsible for plan administration, including recordkeeping, compliance testing, and reporting. A good TPA will also offer employee education and support, ensuring that the business and its employees meet regulatory requirements and have access to high-quality plan administration services.
How does the required minimum distribution (RMD) rule apply to employees of a small business 401(k) plan who are still working after age 73, and what options does the employer have to manage or defer RMDs for these employees?
Employees who are still working after age 73 are not required to take RMDs from their 401(k) plan until they retire or separate from the business. Employers have the option to allow employees to defer RMDs if they are still working, as long as the employer’s plan permits this. The employer must monitor employees who reach age 73 and ensure they are informed of their RMD requirements once they leave the company.
What are the legal and operational risks for small businesses that fail to properly administer their 401(k) plan, particularly in light of recent IRS and Department of Labor audits, and how can these risks be mitigated through diligent record-keeping and plan review?
The main risks are penalties for non-compliance, plan disqualification, and back taxes owed. To mitigate these risks, businesses should regularly review plan operations with legal and financial advisors, maintain detailed records, and use professional third-party administrators to ensure compliance with IRS and DOL regulations. Ensuring timely reporting and correcting any errors quickly through IRS correction programs is also important.
