A traditional 401(k) plan offers the maximum flexibility of the three types of plans. Employers have discretion as to make contributions on behalf of all participants, to match employees’ deferrals, or do both. These contributions can be subject to a vesting schedule (which provides that an employee’s right to employer contributions becomes nonforfeitable only after a period of time). In addition, a traditional 401(k) allows participants to make pre-tax contributions through payroll deductions. Annual testing ensures that benefits for rank-and-file employees are proportional to benefits for owners/managers.
A safe harbor 401(k) plan is similar to a traditional 401(k) plan, but, among other things, must provide for employer contributions that are fully vested when made. However, the safe harbor 401(k) is not subject to many of the complex tax rules that are associated with a traditional 401(k) plan, including annual nondiscrimination testing.
An automatic enrollment 401(k) plan allows an employer to automatically deduct a fixed percentage or amount from an employee’s wages and contribute that amount to the retirement plan unless the employee has affirmatively chosen to contribute nothing or a different amount. These automatic enrollment contributions qualify as elective deferrals.
Revenue Ruling 2009-30 demonstrates ways a 401(k) plan sponsor can include automatic contribution increases in its plan.
Notice 2009-65 provides sample automatic enrollment plan language that a 401(k) plan sponsor can adopt with automatic IRS approval.
The traditional, safe harbor and automatic enrollment 401(k) plans are for employers of any size and can be combined with other retirement plans.
A SIMPLE 401(k) plan was created so that small businesses could have an effective cost-efficient way to offer retirement benefits to their employees. A SIMPLE 401(k) plan is not subject to the annual nondiscrimination tests that apply to the traditional plans. Similar to a safe harbor 401(k) plan, however, the employer is required to make employer contributions that are fully vested. This type of 401(k) plan is available to employers with 100 or fewer employees who received at least $5,000 in compensation from the employer for the preceding calendar year. In addition, employees that are covered by a SIMPLE 401(k) plan may not receive any contributions or benefit accruals under any other plans of the employer.
Personally, as a CPA, I prefer businesses choose the Simple 401(k). It is very specific about the limited options available to employers and employees. Only for companies with less than 100 employees this plan allows smaller companies to compete with larger employers on a “retirement plan” basis. It provides for “tax deferred”, payroll deducted employee contributions, employer matching and almost no administration costs.