What Are Key 401(k) Terms?

This page contains a list of helpful terms related to a 401( k ).

• 401( k ): A defined contribution retirement plan offered through employers. Traditional contributions for a 401( k ) are tax-deferred--meaning employer and employee contributions are deducted pre-tax, and the employee only pays tax upon withdrawal (usually in retirement).

• Average Deferral Percentage (ADP): One of the ERISA-defined compliance tests that a defined contribution plan must pass (except safe-harbor). It is calculated by comparing the deferral percentages of Highly Compensated Employees (HCEs) to non-HCEs. For more details around the calculation, see this IRS link.

• Actual Contribution Percentage (ACP): One of the ERISA-defined compliance tests that a defined contribution plan must pass (except safe-harbor). It is calculated by comparing the employer and after-tax employee contribution percentages of HCEs to non-HCE employees. For more details around the calculation, see this IRS link.

• Beneficiary: An individual, charity, or trust with a valid US TIN that inherits a client's existing 401( k ) funds in the event of the client's passing.

• Catch-up Contribution: A type of retirement savings contribution that allows people over 50 to make additional contributions to their 401( k ) and/or individual retirement accounts.

• Catch-up Deduction: An increase in the deduction from the employee's paycheck to make up for a missed or under-payed contribution.

• Compensation: Per the IRS, this includes all wages, salaries and other amounts received that are included in the employee’s gross income.

• Contributions: The amount designated to deposit into one's 401( k ) each month.

• Deferral: To delay recognizing certain revenues or expenses on the income statement until a later, more appropriate time.

• Distribution: Money taken out of a 401( k ). Generally, distributions of elective deferrals cannot be made until one of the following occurs:

  • Death, become disabled, or otherwise have a severance from employment.

  • The plan terminates and no successor defined contribution plan is established or maintained by the employer.

  • Reaches the age of 59½ or incurs a financial hardship.

• Early Withdrawal: Retrieving funds from one's 401( k ) before retirement is reached. Typically there is a 10% early withdrawal penalty (called an excise tax), on top of the employee’s income tax rate. A list of non-excise tax withdrawals can be found here.

• Elective Deferrals: The amounts contributed to a plan by the employer at the employee's election and which, except to the extent they are designated Roth contributions, are excludable from the employee's gross income.

• ERISA: In 1974, the Employee Retirement Income Security Act (ERISA) was enacted to regulate most types of employee benefit plans.

• Fidelity Bond: An ERISA requirement that every fiduciary of an employee benefit plan and every person who handles plan funds be bonded. These bonds cover the plan from loss of assets due to fraud or dishonesty. The bond is required to insure 10% of assets.

• Fiduciary: An individual or individuals that are exercising discretion or control over the plan. Essentially someone who is acting on behalf of the plan, its participants and beneficiaries. See more from the Department of Labor here.

• Hardship distribution: A 401( k ) plan may allow you to receive a hardship distribution because of an immediate and heavy financial need. Hardship distributions from a 401( k ) plan are limited to the amount of the employee’s elective deferrals and generally do not include any income earned on the deferred amounts. If the plan permits, certain employer matching contributions and employer discretionary contributions may also be included in hardship distributions. Hardship distributions cannot be rolled over to another plan or IRA.

• Highly-Compensated Employee: Please review this Help Center article in regards to Highly-Compensated Employees.

• IRA: or "Individual Retirement Arrangements", allow you to make tax-deferred investments to provide financial security when you retire. 

• Key Employee: Please review this Help Center article in regards to Key Employees. 

• Loan: Some plans allow participants to borrow money from their 401( k ), though not all do because of the cost associated with administering them. A participant is allowed to take a loan of 50% of their vested balance, up to $50,000. The employer is also responsible for setting up the loan in their payroll. 

• Matching: When an employer decides to contribute to an employee’s account if the employee contributes. For example, an employer will contribute 3% if the employee contributes 3%.

• Mutual Funds: The primary investment options in a 401( k ). They are traded only once a day, and it is after market close. Each fund is a basket of stocks. For example, you can buy into a fund that holds all the stocks in the S&P 500 index.

• Non-Elective Contribution: An employer contribution that is given to all eligible employees, regardless of their employee contribution. A non-elective contribution of 3% of employee salary qualifies a plan as a Safe Harbor Plan.

• Non-Discrimination: To help ensure that companies extend their 401( k ) plans to all employees regardless of pay, an IRS rule limits the maximum deferral by the company's key or highly compensated employees (HCEs) based on the average deferral by the company's non-highly compensated employees (NHCEs). This is referred to as Non-Discrimination Testing - see this page for more detail.

• Participant: An eligible employee who is covered by a retirement plan.

• Plan Sponsor: The party, typically a company or employer, who sponsors the retirement plan for the benefit of their employees.

• Rollover: A rollover occurs when a participant directs the transfer of the money in his or her retirement account or IRA to a new plan or IRA.

• Safe Harbor 401( k ): A defined contribution plan that exempts the employer from non-discrimination testing. Typically it requires a 4% company match for every participant and matches are 100% vested from day one.

• Top-Heavy Test: One of the ERISA-defined tests that a defined contribution plan must pass (except safe-harbor). It is calculated by comparing the total value of plan assets belonging to key employees to those of non-key employees. For more details around the calculation see this IRS link.

• Vesting: The schedule and length of time that an employee must meet to keep the employer’s matching contributions. For example, an employee gets to keep 50% of employer match after 1 year of service and 100% after 2 years of service. The employee always keeps their own contributions.