By: Ronald G. Silbert
Various types of retirement plans are qualified and therefore tax-exempt until the benefits are distributed. A 401(k) Plan is a defined contribution profit sharing plan with an employee salary reduction component that allows employees to defer taxes on a portion of their salary on a pre-tax basis. An employer match or contribution separate from the employee salary reduction contribution increases the amount accumulated each year. Other types of qualified plans are defined benefit pension plans or an employee stock ownership plan (that is usually a defined contribution plan). This article is limited to 401(k) plans, the name of which is derived from the Internal Revenue Code (the “Code”) Section that governs these types of plans.
1. Qualified Plan Benefits.
A qualified retirement plan provides for retirement benefits upon reaching a retirement age specified in the Plan document, with a tax-free buildup. A qualified plan has to meet various requirements under the Internal Revenue Code. There are specific provisions of the Internal Revenue Code that apply to 401(k) plans and all qualified plans.
2. Plan Documents.
The first step in setting up a 401(k) plan is to adopt a plan document. Many investment companies, such as Fidelity Investments, offer pre-qualified plan documents that have been approved by the Internal Revenue Service. Using a pre-approved plan eliminates the requirement to file with the IRS for a determination letter for the initial adoption of the plan document. The adoption agreements provided by the plan document sponsor have various options to select, such as the vesting schedule and the years of service and age to enter the plan. A knowledgeable retirement plan advisor is needed to properly complete the adoption agreement.
3. Contribution Limits.
The amount that can be contributed to a 401(k) profit-sharing plan has limits prescribed by the Internal Revenue Code, which the limits are adjusted each year. The 2026 annual limit for salary reduction contributions is $24,500. There is also a Code Section 415 (c) limit on the total amount that can be allocated to an employee’s account each year. The 2026 limit is $72,000. The compensation that can be used for plan contribution calculations is also adjusted each year, with $360,000 being the 2026 compensation limit. These limits are adjusted for inflation each year and will be increased for the year 2027.
4. Age 50 and 60 Catch-up Contributions.
The annual salary reduction compensation limit is increased by a catch-up contribution for people who are age 50 (an additional $8,000 beyond the $24,500 limit), and a super catch-up contribution for ages 60-63 (an additional $3,500 for 2026), to be contributed. These catch-up contributions are not subject to the current $72,000 Code Section 415 (c) allocation limit. As of January 1, 2026, the catch-up contributions have to be post-tax Roth contributions for people with compensation in the prior year of $150,000 for 2026, as adjusted for inflation each year. This means that the catch-up contribution amount is taxable income. However, the tax has to be paid from the person’s salary and does not reduce the contribution amount.
5. Discrimination Testing and Safe Harbor Contributions.
There are Code provisions that limit the amount that can be contributed by salary reduction contributions for highly compensated persons ($160,000 for 2026) as compared to the non-highly compensated person salary reduction contributions. In order to avoid discrimination testing, employers can adopt one of several safe harbors allowed by the Internal Revenue Code, one of which is for the employer to contribute a fully vested 3% contribution each year.
6. Vesting.
There is limited vesting schedules allowed under the Code. A typical vesting schedule provides for vesting over 6 years, with respect to employer matches or employer plan contributions. This 6-year schedule provides 0% for less than 2 years of service; 20% after two years, 40% after 3 years, 60% after 4 years, 80% after 5 years, and 100% after 6 years of service. A year of service is defined as a year when the employee works at least 1,000 hours. Employee salary reduction contributions are always 100% vested.
7. Beneficiary Designations.
To provide for the potential death of a participant before he or she retires, each participant should complete a beneficiary designation to identify which persons would receive their retirement account. However, a qualified plan has to provide that the spouse of the participant is the required beneficiary, if the spouse survives the participant. Beneficiary designations are an important part of plan administration.
8. Plan Loans.
Qualified plans can allow plan loans, but they are limited to the lesser of $50,000 or 50% of the vested account balance, and the loans must be repaid in substantially equal quarterly installments over 5 years. The failure to repay the loan on time results in a deemed taxable distribution in the year the repayment was not made.
9. Plan Distributions.
Plan distributions are subject to certain age provisions. A distribution before age 59 ½ is subject to an additional 10% tax under Code Section 72(t) along with regular income taxes. There are also required distribution ages, which is age 73 for people reaching that age in 2023, or age 75 for people reaching that age in 2032. A penalty applies if the required minimum distributions are not taken. However, a person who is not a 5% owner of a company does not have to take a distribution until they retire.
10. Asset Protection.
One of the benefits of a qualified plan is that the retirement account is not subject to the claims of creditors until the funds are distributed to the participant. Code Section 401(a) (13). An exception exists for a qualified domestic relations order (QDRO), which is entered by a court and can be used to have benefits paid to a former spouse or dependent child. There are various requirements for a court order to be a QDRO. The IRS can also levy against retirement plan benefits.
11. Plan Administration.
The administration of a qualified plan involves various annual requirements. One is that a Form 5500 has to be filed each year by July 31st (or October 15th if a timely extension is requested), with an exception for one participant plans with assets under a certain level. A summary plan description (“SPD”) has to be provided at the time a plan is adopted and updated when material plan amendments are adopted. The SPD is also to be provided to each new participant when a new employee has been hired and meets the age and hours of service requirement to enter the plan. Each year, a participant is to be given a statement of the person’s account balance as of the end of the year.
12. Plan Investments.
A plan participant is allowed to direct the investment of the participant’s account. However, the plan sponsor has a fiduciary obligation to monitor the investment choices and to eliminate non-performing funds or exchange-traded funds. This is currently an area of litigation for many plan sponsors.
This article is not intended to be legal advice. For questions, you can contact Ron Silbert at ron.silbert@sfbbg.com.
