What Is a Workplace Savings Plan and How Does It Work?

Saving for retirement or other long-term financial goals is easier when your employer offers a workplace savings plan. These plans allow employees to set aside money directly from their paycheck, often with tax advantages and potential employer contributions. Understanding how these plans function helps maximize benefits and avoid costly mistakes.

Eligibility Criteria

Employers set specific participation requirements, typically based on tenure, hours worked, or job classification. Many require employees to complete a minimum service period—often one year—before becoming eligible. IRS regulations permit up to a 12-month waiting period and require at least 1,000 hours of work before granting access. Some companies waive these waiting periods to attract talent.

Age restrictions also apply. The IRS allows employers to set a minimum participation age of 21, though some lower this to encourage early saving. Part-time and seasonal employees often face additional barriers, but the SECURE Act 2.0 mandates that long-term part-time workers—those with at least 500 hours of service in three consecutive years—must be allowed to participate in 401(k) plans starting in 2025.

Certain employee groups may be excluded. Unionized employees are often covered under separate agreements, and nonresident aliens without U.S. income are typically ineligible. Highly compensated employees (HCEs), defined by the IRS in 2024 as those earning more than $155,000 in the prior year or owning more than 5% of the company, may face contribution limits if the plan fails nondiscrimination testing. Plans must pass compliance tests, such as the Actual Deferral Percentage (ADP) test, to ensure contributions do not disproportionately favor HCEs.

Common Plan Formats

Workplace savings plans come in multiple forms, each with distinct contribution limits, tax treatment, and withdrawal rules. Understanding these differences helps employees and employers make informed decisions.

401(k)

A 401(k) is the most common employer-sponsored retirement plan in the private sector. Employees contribute pre-tax or Roth (after-tax) dollars through payroll deductions. In 2024, the employee contribution limit is $23,000, with an additional $7,500 catch-up contribution for those 50 and older. Employers may offer matching contributions, subject to a total cap of $69,000 (or $76,500 with catch-up contributions).

These plans must comply with Internal Revenue Code Section 401(k) and undergo nondiscrimination testing to ensure benefits are not skewed toward highly compensated employees. Safe harbor 401(k) plans, which require mandatory employer contributions, can bypass these tests. Withdrawals before age 59½ generally incur a 10% early distribution penalty unless an exception applies, such as a qualified hardship withdrawal or the Rule of 55, which allows penalty-free withdrawals for employees who leave their job at 55 or older.

403(b)

A 403(b), or tax-sheltered annuity (TSA) plan, is available to employees of public schools, tax-exempt organizations under Section 501(c)(3), and certain ministers. These plans function similarly to 401(k)s but have unique regulatory differences.

For 2024, contribution limits match those of 401(k) plans: $23,000 for employees, with a $7,500 catch-up contribution for those 50 and older. Employees with at least 15 years of service at the same employer may contribute up to an extra $3,000 annually, subject to a lifetime cap of $15,000.

Unlike 401(k)s, 403(b) plans are exempt from certain nondiscrimination tests if they do not offer employer matching contributions. Investment options are often limited to annuities and mutual funds. Early withdrawals before age 59½ generally incur a 10% penalty unless an exception applies.

457(b)

A 457(b) is designed for state and local government employees and certain tax-exempt organizations. These plans allow pre-tax and Roth contributions, with the same 2024 contribution limits as 401(k) and 403(b) plans: $23,000 for employees and a $7,500 catch-up contribution for those 50 and older.

A key distinction is the special catch-up provision available in the three years before an employee’s normal retirement age, allowing contributions up to double the standard limit ($46,000 in 2024) if the participant has unused contribution capacity from prior years. Unlike 401(k) and 403(b) plans, 457(b) plans do not impose a 10% early withdrawal penalty, making them more flexible for employees who may need access to funds before age 59½.

Governmental 457(b) plans must follow Internal Revenue Code Section 457 rules, while non-governmental 457(b) plans face stricter distribution restrictions, often requiring lump-sum withdrawals upon separation from service. These plans are also considered unfunded, meaning assets remain part of the employer’s general assets and could be subject to creditor claims if the employer becomes insolvent.

Employer Contributions

Employers enhance workplace savings plans by contributing funds on behalf of employees, typically through matching or non-elective contributions. Matching contributions are based on employee deferrals, often structured as a percentage of salary. A common formula is a 100% match on the first 3% of salary deferred, then 50% on the next 2%, encouraging employees to contribute at least 5% to maximize employer support.

Non-elective contributions do not depend on employee participation. Employers may deposit a fixed percentage of salary for all eligible workers, regardless of whether they contribute. This approach is frequently used in safe harbor plans, which exempt employers from certain compliance tests. A common safe harbor formula is a 3% non-elective contribution for all employees or a matching structure of 100% on the first 4% deferred.

Some employers also provide discretionary profit-sharing contributions, which vary based on company performance. Unlike matching contributions, these do not require employee deferrals and can be adjusted annually. Profit-sharing contributions are subject to a total contribution limit of $69,000 in 2024 (or $76,500 with catch-up contributions).

Tax Considerations

Workplace savings plans offer tax advantages based on how contributions, earnings, and withdrawals are treated. Traditional contributions reduce taxable income in the year they are made, allowing investments to grow tax-deferred until withdrawn, at which point they are taxed as ordinary income. Roth contributions, made with after-tax dollars, allow tax-free withdrawals if certain conditions are met, such as the five-year holding period and reaching age 59½.

Investment earnings grow tax-deferred or tax-free, depending on the contribution type. Required minimum distributions (RMDs) apply to most traditional accounts starting at age 73 in 2024, with penalties for failing to withdraw the required amount set at 25% of the shortfall, reduced to 10% if corrected in a timely manner. Roth 401(k)s historically required RMDs, but the SECURE Act 2.0 eliminated this requirement starting in 2024, aligning them with Roth IRAs.

Vesting Schedules

Employer contributions may be subject to vesting schedules, determining when employees gain full ownership of these funds. Employee contributions are always 100% vested immediately, but employer contributions may require a certain length of service before becoming fully accessible.

Vesting schedules generally follow one of two formats: cliff or graded. Cliff vesting grants employees 0% ownership of employer contributions until a specific service milestone is met, at which point they become fully vested. Graded vesting allows employees to gain partial ownership over time, often increasing in 20% increments annually until full vesting is reached after six years, the maximum allowed under ERISA guidelines.

Distribution Rules

Withdrawals from workplace savings plans are regulated to ensure funds are used primarily for retirement. Qualified distributions occur after reaching age 59½ or upon retirement, with traditional accounts taxed as ordinary income. Non-qualified withdrawals, taken before meeting eligibility criteria, generally incur a 10% penalty unless an exception applies.

Hardship withdrawals are available for immediate financial needs, such as medical expenses or eviction prevention, but cannot be repaid to the plan. Some plans allow in-service withdrawals for employees who have reached a certain age, typically 59½, without requiring separation from employment.

Rollover Options

When employees leave a job, they can roll over their workplace savings plan balance to an IRA or a new employer’s plan to maintain tax deferral. Alternatively, they can take a lump-sum distribution, which triggers immediate taxation and, if under age 59½, a 10% early withdrawal penalty. Some plans allow partial rollovers, enabling employees to transfer a portion of their balance while keeping the rest in the existing plan.