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Workings of a 401K Plan


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Providing a retirement plan can definitely help your business attract and retain the best employees. In considering different retirement plan options, you may be asking yourself how to get started.

In setting up a 401k plan you will need to meet legal requirements to ensure that you and your employees can take advantage of the tax breaks. First, you need to decide which type of 401k plan you’d be interested in:

  • Safe harbor 401k, which is similar to the traditional 401k, except that employees are fully vested in the employer’s contributions when they’re made. Also, you don’t have to make sure that highly compensated employees don’t benefit from the plan more than other employees, as you do with a traditional 401k.
  • Simple 401k, which is similar to the safe harbor 401k but is only available to employers with 100 or fewer employees.
  • Traditional 401k plan, which is the most flexible. You decide whether to make contributions on behalf of your employees, match their contributions, or do both (or neither). You also determine when employees have the vested right to your contributions.

How does a 401k plan work from the employer’s standpoint?

You must prepare a written plan. Federal law determines which employees are eligible to participate and the amounts they can contribute. You decide on how much you will contribute to the plan and how much of the employees’ contributions you will match.

Then you need to arrange for a trust fund for the plan’s assets, and name a trustee. The trustee handles all the contributions to the plan, invests the plan assets and makes distributions from the plan.

You must set up a comprehensive record-keeping system to keep track of contributions, investments, earnings and losses, administrative expenses and distributions. Separate accounts must be kept for each participant. The annual report that must be filed with the federal government for the fund is prepared based on this record-keeping system.

You must provide information on the plan’s benefits and requirements to all employees. This document should explain how the 401k plan works, when and how employees become eligible, contributions to the plan, when employees become vested, and how to claim benefits. The participants’ basic rights under the Employee Retirement Income Security Act must be explained as well.

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