A Breakdown of the Different Types of 401k Plans

A 401(k) is an employer-sponsored retirement savings plan that offers tax advantages. It allows employees to contribute a portion of their wages to an individual account, where funds are invested in options like mutual funds and stocks. The money in the account grows over time from investment returns, and its tax treatment is designed to encourage long-term saving.

Traditional and Roth 401(k) Contributions

The main difference between 401(k) contribution types is their tax treatment. A Traditional 401(k) is funded with pre-tax dollars, meaning contributions are deducted from a paycheck before income taxes are calculated. This reduces the employee’s current taxable income. For example, an employee earning $60,000 who contributes $5,000 to a Traditional 401(k) is only taxed on $55,000 of income for that year.

Contributions and investment earnings in a Traditional 401(k) grow on a tax-deferred basis. No capital gains or dividend taxes are paid while the money remains in the plan. Taxes are due upon withdrawal, when distributions are taxed as ordinary income. This can be advantageous for those who expect to be in a lower tax bracket during retirement.

A Roth 401(k) operates on an after-tax basis. Contributions are made after income taxes have been paid, so there is no upfront tax deduction. An employee earning $60,000 who contributes $5,000 to a Roth 401(k) is still taxed on the full $60,000. The benefit of this approach comes during retirement.

With a Roth 401(k), both contributions and all investment earnings grow completely tax-free. Qualified withdrawals in retirement are not subject to federal or most state income taxes. To be qualified, the account must be open for at least five years, and the withdrawal must occur after the account holder reaches age 59½, becomes disabled, or upon their death.

Any matching funds from an employer are always made on a pre-tax basis, regardless of an employee’s contribution choice. This means the employer match is deposited into a separate pre-tax balance. When an employee with a Roth 401(k) takes a distribution, the portion from their own Roth contributions is tax-free, while the portion from employer matching funds will be taxed as ordinary income.

Safe Harbor 401(k) Plans

A Safe Harbor 401(k) relieves employers from annual nondiscrimination testing (NDT). These IRS tests, the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP), ensure a plan does not disproportionately benefit highly compensated employees (HCEs) over non-highly compensated employees (NHCEs). A Safe Harbor plan automatically satisfies these requirements, avoiding complex calculations and potential corrective actions.

These plans require a mandatory employer contribution that is 100% immediately vested, meaning the funds belong to the employee as soon as they are deposited. Employers have two main formulas for these contributions. The first is a matching contribution, such as a 100% match on the first 3% of an employee’s compensation, plus a 50% match on the next 2%.

An employer can also make an enhanced matching contribution, which must be at least as generous as the basic formula, like a 100% match on the first 4% of contributions. The second option is a non-elective contribution, where the employer contributes a minimum of 3% of compensation to all eligible employees, regardless of whether they contribute.

This plan design is attractive for business owners who want to maximize their own retirement savings without being limited by employee participation rates. Since the plan is exempt from NDT, owners and HCEs can contribute up to the annual IRS limit without concern for testing failures.

A variation is the Qualified Automatic Contribution Arrangement (QACA), which combines Safe Harbor rules with automatic enrollment but has different contribution requirements. A QACA basic match could be a 100% match on the first 1% of compensation and a 50% match on deferrals between 1% and 6%. Unlike other Safe Harbor contributions, QACA employer funds can be subject to a two-year cliff vesting schedule.

SIMPLE 401(k) Plans

A SIMPLE 401(k) is a retirement plan for small businesses. To be eligible, an employer must have 100 or fewer employees who earned at least $5,000 in the preceding year. An employer with a SIMPLE 401(k) cannot maintain any other retirement plan.

Employee contribution limits are lower than in other 401(k) types. For 2025, the employee deferral limit is $16,500, with an additional catch-up contribution of $3,500 for those age 50 and over. All contributions from employees and employers are 100% immediately vested.

Employer contributions are mandatory. The business must choose one of two formulas. The first is a dollar-for-dollar matching contribution on employee deferrals, up to 3% of the employee’s compensation. The second is a non-elective contribution of 2% of compensation for every eligible employee, even if they do not contribute.

Like Safe Harbor plans, SIMPLE 401(k)s are exempt from nondiscrimination testing, which simplifies administration. While it shares a name with the SIMPLE IRA, the SIMPLE 401(k) may permit participant loans if the plan allows. The plan does require the annual filing of a Form 5500 with the IRS.

Solo 401(k) Plans

The Solo 401(k) is for self-employed individuals or business owners with no employees other than a spouse. Its appeal is a contribution structure that allows the owner to contribute as both an “employee” and an “employer.”

As the “employee,” the owner can make salary deferrals up to the annual IRS limit. For 2025, this limit is $23,500, plus a $7,500 catch-up contribution for those age 50 or over. These deferrals can be made as Traditional (pre-tax) or Roth (after-tax) contributions, if the plan allows.

As the “employer,” the individual can make an additional non-elective contribution based on their income. For corporations, the contribution is up to 25% of W-2 compensation. For sole proprietors, the calculation is based on net earnings from self-employment, which is about 20% after self-employment tax deductions.

This dual structure allows for a much higher total contribution limit compared to other retirement plans. The combined employee and employer contributions cannot exceed the lesser of 100% of compensation or the overall IRS limit of $70,000 for 2025. If the plan’s assets exceed $250,000, the owner must file an annual Form 5500-EZ with the IRS.