What is a 401(k) plan?

A 401(k) plan technically is not a separate type of plan; it is a profit-sharing or stock bonus plan that contains a "qualified cash or deferred arrangement." Under a qualified cash or deferred arrangement, plan participants may elect to contribute a portion of their current compensation, on a pre-tax basis, to the plan. Such contributions are commonly referred to as "elective contributions" or "elective deferrals." A plan that contains such an arrangement is commonly referred to as a "401(k) plan" or a "K plan" after section 401(k) of the Internal Revenue Code, which governs such arrangements. The Federal Thrift Savings Plan is an example of a 401(k) plan. Special rules apply to 401(k) plans, including nondiscrimination requirements and lower limits on the amount an employee can elect to contribute.

To encourage employees to participate in a 401(k) plan, many employers provide matching contributions. For example, a plan could provide that the employer will make matching contributions equal to 50 percent of the employees' elective contributions, up to a maximum of 3 percent of compensation. Employers are not required to offer a match; however, many employers provide a match because doing so makes it easier for the plan to satisfy applicable nondiscrimination rules.

In addition to or in lieu of matching contributions, some employers make "qualified non-elective contributions" for employees participating in a 401(k) plan. "Qualified non-elective contributions" are contributions that are made by the employer without regard to whether the employee makes elective contributions, is 100% vested or meets certain other requirements. Like matching contributions, such contributions may make it easier for plans to satisfy the applicable nondiscrimination rules.

Matching contributions and qualified non-elective contributions can be made to the same plan that contains the 401(k) cash or deferred arrangement or to another plan of the employer.

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