401(k) Plan: What It Means for Employers

What it means in practice

What the term means. Section 401(k)(2) of the Internal Revenue Code defines a qualified cash or deferred arrangement as part of a profit-sharing or stock bonus plan under which a covered employee may elect to have the employer pay an amount either to a trust under the plan or to the employee in cash. The IRS calls a 401(k) "a qualified plan that includes a feature allowing an employee to elect to have the employer contribute a portion of the employee's wages to an individual account under the plan." For employers it is both a benefit and a payroll process. For other plans built on section 401(a), see 401(a) plans.

Who can participate. The IRS says a plan may exclude employees under age 21, those without a year of service, and those covered by a collective bargaining agreement where retirement benefits were bargained in good faith. A plan cannot require more than 1 year of service to participate, and employees cannot be excluded merely because they are older.

Kinds of contributions. Elective deferrals are contributions the employer makes at the employee's election. Traditional deferrals are made through payroll deduction before federal income tax and are not reported as taxable income on the employee's return. A plan may also let employees designate some or all deferrals as Roth elective deferrals, which the IRS says are included in taxable income in the year of the deferral. On top of deferrals, the plan document may provide for employer matching contributions (the IRS example is 50 cents for each dollar deferred) and nonelective contributions, which go to eligible participants whether or not they defer. Employees are always 100% vested in their own deferrals; a traditional plan may apply a vesting schedule to employer contributions.

2026 dollar limits. The IRS cost-of-living table for 2026 sets the elective deferral limit under section 402(g) at $24,500, the catch-up limit at $8,000, the defined contribution plan limit at $72,000 and annual compensation at $360,000. The deferral limit applies per person across all plans. The $72,000 section 415(c) limit on annual additions covers deferrals (not catch-ups), employer contributions and forfeitures; the IRS gives $80,000 including catch-ups, or up to $83,250 for ages 60 to 63. The employer's deduction generally cannot exceed 25% of eligible participants' compensation. The highly compensated employee (HCE) threshold for 2026 remains $160,000.

2027 limits. As of November 2, 2026, the IRS COLA page and the IRS newsroom had not yet announced 2027 retirement plan limits, so this entry gives none. Check the IRS COLA page before setting up January 2027 payroll.

Catch-up contributions and the Roth requirement. If the plan allows, a participant age 50 or older by year end may defer an extra $8,000 for 2026, or up to $11,250 for employees who turn 60, 61, 62 or 63 in the year. Under section 414(v)(7), if a participant's prior-year wages (as defined in section 3121(a)) from the sponsoring employer exceed the threshold, catch-ups are allowed only as designated Roth contributions. Notice 2025-67 sets the threshold for 2025 wages, applied to 2026 catch-ups, at $150,000. If the rule applies to anyone, the plan must let every eligible participant make Roth catch-ups. The final regulations (IR-2025-91) generally apply to taxable years beginning after December 31, 2026; until then plans may use a reasonable, good faith interpretation, and the Notice 2023-62 transition period ended December 31, 2025.

Automatic enrollment for new plans. SECURE 2.0 added section 414A, which generally requires a 401(k) arrangement to be an eligible automatic contribution arrangement. Proposed regulations (90 FR 3092, January 14, 2025) explain that the initial default deferral must be 3% to 10% of pay, rising one percentage point a year to a maximum of at least 10% and not more than 15%, with permissible withdrawals allowed. Exceptions include SIMPLE 401(k) plans, arrangements established before December 29, 2022, governmental and church plans, businesses in existence less than 3 years, and businesses normally employing 10 or fewer employees. Until final regulations apply, a reasonable, good faith interpretation of section 414A is treated as compliant; as of this review only the proposed rule had been published.

How deferrals flow through payroll. Publication 15 (2026) lists elective 401(k) deferrals as generally exempt from income tax withholding (subject to the section 402(g) limit) but taxable for Social Security, Medicare and FUTA, while employer contributions to a qualified plan are exempt from all three. So a traditional deferral is a pre-tax deduction for income tax only. On the Form W-2, the 2026 instructions say not to include elective deferrals in box 1, to report them in box 3 as Social Security wages and box 5 as Medicare wages, and to show them in box 12 with code D. Designated Roth contributions are subject to income tax withholding and FICA, are included in boxes 1, 3 and 5, and are reported with code AA. The instructions also say to check the box 13 "Retirement plan" box for an employee who was an active participant during the year.

Getting deferrals to the plan on time. Under the Department of Labor plan asset regulation, withheld amounts become plan assets as of the earliest date they "can reasonably be segregated from the employer's general assets," and for a pension plan never later than the 15th business day of the month after the month they would have been paid in cash. Plans with fewer than 100 participants at the start of the plan year have a safe harbor: deposits by the 7th business day after that pay date are treated as timely. Business days exclude weekends and federal holidays. The IRS Fix-It Guide stresses that the 15th-business-day rule "isn't a safe harbor," and that late deposits can be a prohibited transaction with an initial excise tax of 15% of the amount involved; DOL's Voluntary Fiduciary Correction Program covers late participant contributions. Matching and other employer contributions must be made by the employer's tax return due date, including extensions, to be deductible for that year.

Safe harbor and SIMPLE 401(k) plans. A safe harbor 401(k) requires fully vested employer contributions and is not subject to the annual ADP and ACP tests. IRS guidance describes the basic choices as a match of 100% of deferrals up to 3% of pay plus 50% of deferrals between 3% and 5%, or a 3% nonelective contribution for every eligible employee, and requires a notice to eligible employees, deemed timely if given 30 to 90 days before the plan year. A SIMPLE 401(k) is open to employers with 100 or fewer employees who earned at least $5,000 in the prior year; the employer must make either a dollar-for-dollar match up to 3% of pay or a 2% nonelective contribution, and participants cannot receive contributions under any other plan of the employer.

Nondiscrimination testing. Traditional 401(k) plans must be tested each year. The ADP test compares the average deferral rates of HCEs and non-HCEs, counting pre-tax and Roth deferrals but not catch-ups; the ACP test does the same for matching and after-tax contributions. The HCE average passes if it does not exceed the greater of 125% of the non-HCE average or the lesser of 200% of that average and that average plus 2 percentage points. HCEs are generally 5% owners (including family members by attribution) and employees paid above the prior-year threshold. The plan generally has 2 1/2 months after the plan year to correct excess contributions without the 10% excise tax.

Fiduciary duties and Form 5500. DOL explains that fiduciary status depends on functions performed, not titles. Fiduciaries must act solely in the interest of participants and beneficiaries, act prudently, follow the plan documents, diversify investments and pay only reasonable plan expenses, and may be personally liable to restore losses. Those handling plan funds generally need a fidelity bond. Plan administrators generally file a Form 5500 electronically through EFAST2; the IRS lists the due date as the last day of the seventh month after the plan year ends (July 31 for a calendar-year plan), with extensions on Form 5558. Most one-participant plans with $250,000 or less in assets are exempt.

Step by step for an employer. (1) Confirm eligibility under the plan document and, for a new plan, the automatic enrollment default. (2) Record each deferral election, pre-tax or Roth. (3) Each payroll, subtract pre-tax deferrals from income tax wages only, leaving Social Security, Medicare and FUTA wages unchanged. (4) Track year-to-date deferrals against $24,500 for 2026 plus any catch-up, applying the Roth catch-up rule. (5) Send deferrals to the plan as soon as they can be segregated. (6) Fund employer contributions under the plan formula. (7) At year end, report codes D and AA and box 13 on Form W-2 and give the administrator testing data.

Example 1 (illustration): one paycheck. An employee paid $3,000 every two weeks elects a 6% pre-tax deferral, so $180 goes to the plan. Federal income tax withholding is figured on $2,820, while Social Security and Medicare tax are figured on the full $3,000. Over 26 paychecks with no other deductions, box 1 shows $73,320, boxes 3 and 5 show $78,000, and box 12 shows D 4680.00.

Example 2 (illustration): safe harbor match. An employee earning $60,000 defers 4% ($2,400). Under the basic safe harbor match the employer contributes 100% of the first 3% of pay ($1,800) plus 50% of the next 1% ($300), or $2,100. Under the 3% nonelective alternative, every eligible employee would receive $1,800 whether or not they defer.

Example 3 (illustration): ADP limit. If non-HCEs defer an average of 4% of pay, 125% of that is 5%, and the lesser of 200% (8%) and 4% plus 2 points (6%) is 6%. The greater figure is 6%, so the HCE average may not exceed 6%.

Example 4 (illustration): deposit timing. A plan with 40 participants withholds deferrals from wages paid Friday, November 6, 2026. Skipping weekends and Veterans Day (Wednesday, November 11, a 2026 federal holiday per OPM), the 7th business day is Wednesday, November 18. The outer limit, the 15th business day of December, is December 21, but the general rule still requires deposit as soon as the money can reasonably be segregated.

Where states differ. Two examples. Pennsylvania's Department of Revenue lists contributions to a qualified deferred compensation plan among items "always taxable" as Pennsylvania compensation, so a pre-tax 401(k) deferral that reduces federal box 1 wages does not reduce Pennsylvania taxable compensation. California's State Treasurer says that, effective January 1, 2026, California employers with one or more employees must provide access to a qualified retirement program or certify an exemption with CalSavers, the state's automatic enrollment IRA; employers that already sponsor a retirement plan can register an exemption.

Question: Are 401(k) deferrals subject to FUTA? Yes. Publication 15 lists elective 401(k) deferrals as taxable for FUTA, and the IRS overview says they are wages for federal unemployment tax.

Question: What if an employee defers more than the limit? The W-2 instructions say to report the actual amounts deferred in box 12, even above the limit, and IRS guidance says excess deferrals should be distributed by April 15 of the following year, reported on Form 1099-R.

Question: Can an employer offer a gift for enrolling? The W-2 instructions permit a de minimis financial incentive of no more than $250 to employees who do not already have a deferral election in effect; it is generally taxable wages.

Question: Who is responsible if a payroll provider deposits late? The IRS Fix-It Guide says the employer is responsible for contributing deferrals to the plan trust and should coordinate with its payroll provider to set deposit procedures.

This entry summarizes federal rules and two state examples; it does not decide whether a particular plan, employee or payment meets them.

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