Key Features
- Tax deferred or Roth deferrals
- Safe harbor funding options
- Matching employer
contributions
- Excellent retirement
investment
- Non-discrimination rules
A Cash or Deferred Arrangement, also known as a "401(k) Plan", is a type of profit sharing plan under
which employees are permitted to defer an elective amount of compensation which is either deducted
from current taxable income or treated as a Roth contribution. These amounts are contributed to the
profit sharing plan on behalf of the participant. Frequently employers provide additional incentive for
such employee salary deferrals by offering matching employer contributions which are related to the
amount of the employee's salary deferred. Thus the name "cash or deferred arrangement" appearing in
Section 401(k) of the Internal Revenue Code refers to the employee's ability to elect to receive his
compensation in cash or to defer it into the plan.
401(k) plans are generally appropriate for employers who are unable or unwilling to provide substantial
retirement benefits but who desire to allow employees the ability to make contributions in amounts
larger than those available to individuals through Individual Retirement Accounts. They are unusually
good investments for those employees who are interested in investing for their retirement because it is
a way of purchasing investments with pretax contributions and of accumulating their funds tax-free. At
retirement, a participant's benefit is equal to the then value of the accumulated investments held on
behalf of the participant.
401(k) plans are subject to strict non-discrimination rules which require that "non-highly compensated"
employees participate in the plan at a rate comparable to the rate at which "highly compensated"
employees participate. Therefore 401(k) plans exist primarily to benefit the rank and file rather than
highly compensated employees. Alternatively, adopting certain safe harbor provisions can help enhance
benefits for owners and other “highly compensated” employees.
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