Overview of 401(k) Plans

This page summarizes the important characteristics of 401(k) plans. The following modules provide more detailed discussion of these points. Links to the detailed modules are provided throughout this page.

In general, 401(k) plans — also called Cash Or Deferred Arrangements (CODAs) — allow employees to choose to have part of their current compensation contributed to a qualified profit-sharing or stock bonus plan. Today, most private-sector employers may establish 401(k) plans for their employees. State and local governments may not maintain cash or deferred arrangements, although tax-exempt organizations may establish 401(k) plans for their employees.

Because a 401(k) plan must be part of an underlying profit-sharing or stock bonus plan, 401(k)s must meet the general qualification rules that apply to all such tax-advantaged plans.

As with other qualified plans, contributions to a 401(k) plan receive favorable tax treatment. Most contributions are tax-deductible and earnings in the plan grow tax-deferred until withdrawn.

Like all qualified plans, 401(k)s may not discriminate in favor of highly compensated employees in terms of coverage, contributions, or benefits. To satisfy this nondiscrimination requirement, a 401(k) plan must satisfy several tests, including the Actual Deferral Percentage (ADP) test and the Actual Contribution Percentage (ACP) test.

Distributions from 401(k)s are generally treated much like distributions from other qualified plans. However, the rules governing withdrawals allow for hardship distributions, which most other qualified plans do not allow. Another important feature is the availability of plan loans, which add liquidity and encourage employee participation.

401(k) plans are generally structured as profit-sharing (sometimes called “bonus plans”) or thrift plans. Both types have become better known simply as 401(k) plans. Additional plan types include:

Under a bonus-type plan, contributions are not usually made until year-end when a traditional bonus is declared. Each employee may then elect to receive the bonus in cash or defer it into the plan. Some plans take an all-or-nothing approach; others allow the employee to split the bonus between cash and a plan contribution.

Under a thrift-type plan, an employee elects a reduced salary (or foregoes a raise), and the difference is contributed to the plan on a per-paycheck basis. Most employers allow employees to change their contribution levels once or twice a year, though there are no legal restrictions on frequency of changes.

Employers with 100 or fewer employees who do not maintain any other qualified plan may adopt a SIMPLE 401(k). The advantage is that complex nondiscrimination tests are deemed satisfied if the plan meets relatively simple contribution and vesting requirements. However, SIMPLE 401(k)s must satisfy all other qualified plan rules. More on SIMPLE 401(k) Plans →

A Solo 401(k) (or “Individual(k)”) is designed specifically for owner-only businesses — businesses employing only the owner and immediate family members, or those whose other employees may be excluded under federal coverage rules (e.g., part-time or seasonal workers). Solo 401(k)s eliminate much of the administrative burden of regular 401(k)s while retaining the higher funding levels available under regular 401(k) rules. More on Solo 401(k) Plans →

Since 2006, the tax code permits Roth 401(k) plans. Like Roth IRAs, these plans allow nondeductible (after-tax) employee contributions, tax-deferred growth, and tax-free withdrawal at retirement under certain circumstances. Unlike Roth IRAs, there is no income limit on Roth 401(k) contributions. More on Roth 401(k) Plans →

Qualified retirement plans are those that “qualify” for favorable tax treatment under ERISA (Employee Retirement Income Security Act of 1974). If a plan meets ERISA’s requirements, employer contributions are tax-deductible as a business expense and employees do not include employer contributions as taxable income. Investment income grows tax-deferred, and withdrawals at retirement are taxed as ordinary income — generally at a lower bracket than during working years.

To be treated as a 401(k) plan, it must:

• Be part of a profit-sharing, stock bonus, pre-ERISA money purchase, or rural cooperative plan
• Be a qualified plan under ERISA
• Require no more than one year of service to participate
• Offer employees the option of receiving cash or deferrals
• Impose annual contribution limits
• Meet special requirements relating to nondiscrimination, elective deferrals, and distributions
• Provide for separate accounting of different types of contributions
• Not require participation as a condition for other benefits

All 401(k) plans must meet the general rules imposed by ERISA. In brief, the plan must:

• Be a written plan that is communicated to employees
• Be for the exclusive benefit of employees or their beneficiaries
• Not discriminate in favor of highly compensated employees
• Meet minimum vesting rules
• Provide that an employee’s entire interest be paid out when the employee retires or reaches the required beginning date for RMDs
• Provide a qualified joint and survivor annuity as a payout alternative
• Allow for rollover of benefits to another qualified plan
• Contain a spendthrift provision
• File various reports with the IRS and the Department of Labor

Unlike other qualified plans that may require longer service periods, 401(k) plans must be open to any full-time adult employee who has provided at least one year of service (a 12-month period with at least 1,000 hours worked). Employers may set shorter eligibility periods but not longer. The employee must be permitted to participate within six months of satisfying the age and service requirements. Special break-in-service rules apply to employees who work fewer than 500 hours in a 12-month period.

To qualify as a 401(k) plan, the amount an employee may defer must be available to the employee as cash. Plans that offer a non-cash benefit (such as health insurance) in lieu of a cash deferral option will not qualify as a 401(k) plan.

401(k) plans must provide a separate account for each participant tracking employer and employee contributions. The plan must allocate gains, losses, and other credits or charges on a reasonable and consistent basis — not discriminating in favor of highly compensated employees. Employers who maintain only one account per employee must treat all contributions as 100% vested.

There are four types of contributions that may be made to a 401(k) plan:

• Elective deferrals: Before-tax funds contributed at the employee’s direction through salary reduction or bonus deferral. Required in all 401(k) plans.
• Voluntary after-tax contributions: After-tax funds set aside by the employee. Earnings on these contributions grow tax-deferred.
• Employer matching contributions: Funds added by the employer, typically as an incentive for employees to participate.
• Nonelective contributions: Employer contributions not tied to employee deferrals, often allocated based on the employer’s profits in proportion to salaries.

Only elective deferrals are required by the tax code; the other three are optional employer additions.

Each employer’s plan will outline the maximum percentage of compensation that employees may contribute, along with any employer matching formula. The tax code imposes two separate dollar ceilings:

Annual additions limit: Total contributions to a participant’s account from all sources — elective deferrals, employer matching, and nonelective contributions — may not exceed the lesser of 100% of compensation or $70,000 (2026). This is the “100% / $70,000 rule.”

Elective deferral limit: The aggregate amount an employee may defer across all 401(k) plans, 403(b) annuities, and SARSEPs is limited to $24,500 (2026). Employees age 50 or older may contribute an additional $8,000 catch-up, for a total of $32,500. Under SECURE Act 2.0, employees who turn age 60, 61, 62, or 63 during 2026 may instead use the super catch-up of $11,250, for a total of $35,750.

More details on 401(k) Contributions →

Vesting refers to the employee’s ownership of retirement savings in a qualified plan. Accumulated savings in a 401(k) plan are generally the result of employer contributions and earnings, employee contributions and earnings, and amounts allocated from plan forfeitures.

The tax code requires full and immediate vesting for employee elective contributions (and all income earned on them), as well as any amounts rolled over into the 401(k). For example, if a plan provides that 60% of an account is vested, it is only matching and nonelective employer contributions that are 60% vested — employee contributions are always fully vested.

Employer contributions may be vested under a deferred vesting schedule — either cliff vesting (full ownership after a specified period) or graded vesting (increasing ownership over time). Deferred vesting provides a powerful incentive for employees to remain with the same employer.

More details on Vesting →

Perhaps the most onerous requirements of a 401(k) plan are the nondiscrimination rules. 401(k) plans may not favor highly compensated employees (HCEs) as to coverage, contributions, or benefits. For 2026, highly compensated employees include:

• Any employee who owned 5% or more of the employer during the current or prior year
• Any employee who received compensation of $160,000 or more (2026, inflation-adjusted) from the employer during the prior year

To satisfy the nondiscrimination requirement, the plan must meet one of two coverage tests:

• Percentage test: At least 70% of all non-HCEs must be covered by the plan
• Ratio test: The percentage of non-HCEs covered must be at least 70% of the percentage of HCEs covered

A plan may appear nondiscriminatory on paper but prove discriminatory in operation. Employers must also satisfy the ADP test (Actual Deferral Percentage) and the ACP test (Actual Contribution Percentage) to measure actual plan funding.

More on Non-Discrimination Rules →

For an arrangement to qualify as a 401(k) plan, an employer may not condition any other employer-provided benefits (other than matching contributions) on an employee’s choice to make or not make elective deferrals. The following may not be conditioned on participation in the 401(k):

• Health benefits (availability, level, or cost)
• Vacations or vacation pay
• Life insurance
• Dental plans
• Legal services plans
• Loans (including plan loans)
• Financial planning services
• Subsidized retirement benefits
• Stock options
• Dependent care assistance
• Benefits under a defined benefit plan
• Nonelective employer contributions under a defined contribution plan

When funds are withdrawn from a 401(k), the distribution is subject to tax. If the initial contribution was made with pre-tax dollars (elective deferrals and employer matching/nonelective contributions), the withdrawal — and all income earned on it — will be fully taxed as ordinary income in the year of withdrawal. An employee’s voluntary after-tax contributions are not retaxed upon withdrawal; only the accrued earnings are taxable.

Funds held in qualified plans are intended for retirement. Withdrawals before “retirement” are generally subject to a 10% premature distribution penalty in addition to ordinary income tax. Penalty-free withdrawals may be made only:

• Upon the employee’s retirement, death, disability, divorce, or separation from service
• When the employee reaches age 59½
• If the employer terminates the plan without establishing a successor plan
• If the employer disposes of its business to an unrelated entity and the employee continues employment with the purchaser

One advantage of a 401(k) over other qualified plans is that hardship distributions are permitted when other financial resources are not readily available.

The tax code requires older participants to begin withdrawing funds from their 401(k). Under SECURE Act 2.0, RMDs must begin at age 73 (age 75 for those born after 1959, beginning in 2033). Participants who continue working past this age may defer RMDs until they retire, unless they own more than 5% of the employer. Failure to take the required annual minimum results in a 25% excise tax on the shortfall (reduced to 10% if corrected within two years under SECURE Act 2.0).

401(k) plans may offer participants the ability to borrow up to 50% of the vested account balance, to a maximum of $50,000. These loans are not treated as taxable distributions if:

• Loans are offered to all participants on a uniform basis
• The loan is secured and carries a reasonable rate of interest
• The loan is repaid within five years (longer for primary residence loans)

If these requirements are not met, the amount borrowed is treated as a taxable distribution — and possibly subject to the 10% premature distribution penalty.

More on 401(k) Distributions →

Most qualified plans, including 401(k)s, are required to provide a Qualified Joint and Survivor Annuity (QJSA) as the default payout option to married participants, unless the participant (with spousal consent) elects otherwise. This rule prevents a participant from electing a “life-only” annuity and thereby leaving a surviving spouse with no retirement benefits.

More on QJSAs and Distributions →