An Overview of 401(k) Plan Regulations

The regulatory framework for 401(k) plans is established by the Internal Revenue Service (IRS) and the Department of Labor under the Employee Retirement Income Security Act (ERISA). These regulations are designed to protect employee retirement savings by ensuring plans are operated fairly and for the exclusive benefit of participants. The rules create a uniform standard for plan management, eligibility, and fund handling to foster confidence and security in the private retirement system.

Contribution Regulations

Regulations for 401(k) contributions address how money can be put into a plan by both employees and employers. The most common contribution is an employee’s elective deferral, where a portion of their salary is directed into their 401(k). These deferrals can be made on a pre-tax basis, reducing current taxable income, or as Roth contributions, made with after-tax dollars for tax-free withdrawals in retirement.

Employers have several options for contributing to employee accounts. Many companies offer a matching contribution based on how much an employee defers. Employers can also make non-elective contributions, often called profit-sharing, which are given to eligible employees regardless of whether they contribute.

The IRS sets annual limits on 401(k) contributions. For 2025, an employee can defer up to $23,500 of their salary, a limit that applies to the combined total of their pre-tax and Roth deferrals. The government adjusts this limit periodically for inflation.

A separate, higher limit exists for total contributions to a 401(k) account in a single year, which includes employee deferrals and all employer contributions. For 2025, this total cannot exceed the lesser of 100% of the employee’s compensation or $70,000. This cap prevents excessive tax-deferred savings.

Catch-Up Contributions

To help individuals nearing retirement, regulations allow for catch-up contributions for participants who are age 50 or older. This provision permits them to contribute an additional amount over the standard employee deferral limit. For 2025, the standard catch-up contribution limit is $7,500.

Beginning in 2025, a new provision allows individuals aged 60, 61, 62, and 63 to make an even higher catch-up contribution of up to $11,250. This rule acknowledges that many people may need to save more aggressively in their later working years.

Plan Participation and Vesting Rules

Federal regulations establish minimum standards for when an employee must be allowed to participate in a 401(k) plan. An employer cannot require an employee to be older than 21 or to have completed more than one year of service. Additionally, companies must allow employees who have worked at least 500 hours per year for two consecutive years to participate.

An employee’s own salary deferrals are always 100% vested, meaning they have an immediate and non-forfeitable right to that money. If an employee leaves the company, they are entitled to take their entire contributed balance with them.

The rules for vesting employer contributions are different. Companies use vesting schedules to encourage retention, with two primary types permitted: cliff vesting and graded vesting.

Under a three-year cliff vesting schedule, an employee becomes 100% vested in all employer contributions after three years of service. A graded schedule allows for partial ownership over time, such as vesting 20% after two years and an additional 20% each year until 100% vested after six years.

Distribution and Loan Regulations

The rules for taking money out of a 401(k) are designed to encourage long-term savings. Any funds withdrawn are treated as ordinary income and are subject to federal and state income tax. For individuals who take a withdrawal before reaching age 59 ½, an additional 10% early withdrawal penalty tax is applied.

There are several exceptions to the 10% early withdrawal penalty, intended to provide financial relief in certain situations. These include withdrawals made due to:

• The account owner’s death, total and permanent disability, or terminal illness
• Certain emergency expenses
• Use by victims of domestic abuse, up to the lesser of $10,000 or 50% of the account balance
• Distributions made as part of a series of substantially equal periodic payments (SEPPs)

401(k) Loans

Many 401(k) plans allow participants to borrow from their own accounts. The maximum amount a participant can borrow is the lesser of $50,000 or 50% of their vested account balance. This limit prevents participants from draining their retirement funds.

The loan must be repaid within five years, with payments made at least quarterly. Both the principal and interest are repaid directly back into the participant’s own 401(k) account. If a participant leaves their job with an outstanding loan, they may be required to repay the full balance quickly to avoid it being treated as a taxable distribution.

Required Minimum Distributions

To ensure tax-deferred accounts are eventually used for retirement income, regulations mandate Required Minimum Distributions (RMDs). These rules compel account holders to begin taking withdrawals once they reach a certain age. The age for starting RMDs is 73 for individuals who turn 72 after December 31, 2022.

The RMD amount is calculated annually based on the prior year-end account balance and the owner’s life expectancy per IRS tables. The penalty for failing to take an RMD is a 25% excise tax on the amount that should have been withdrawn, which can be reduced to 10% if corrected in a timely manner. These RMD rules do not apply to Roth 401(k) accounts during the original owner’s lifetime.

Fiduciary and Administrative Requirements

Every 401(k) plan must have designated fiduciaries who are legally obligated to manage the plan. Under ERISA, a fiduciary is anyone who exercises discretionary control over plan management or assets, which is typically the employer. The primary duty of a fiduciary is to act solely in the interest of the plan’s participants and their beneficiaries.

This duty requires fiduciaries to carry out their responsibilities prudently, diversify plan investments to minimize the risk of large losses, and ensure that only reasonable expenses are paid from plan assets. A breach of these duties can result in personal liability for the fiduciary to restore any losses.

To ensure fairness, plans are subject to annual non-discrimination testing (NDT). These tests verify that the plan does not disproportionately benefit highly compensated employees (HCEs) over non-highly compensated employees (NHCEs). The main tests are the Actual Deferral Percentage (ADP) test and the Actual Contribution Percentage (ACP) test.

A key administrative requirement is the annual filing of Form 5500 with the Department of Labor and the IRS. This form provides detailed information about the plan’s financial condition, investments, and operations, allowing government agencies to monitor compliance.