401(k) Glossary: ePlan’s Guide to Retirement Terminology

Looking to better prepare for your financial future? It may be helpful to have a clearer understanding of the terminology surrounding retirement planning. These terms may seem confusing initially, however, understanding the retirement process can be easier than you think.

We’ve put together a glossary of common terms to help you better understand some of the language associated with your 401(k) plan.

401(k) Plans

Retirement Account

This type of account can be sponsored by an employer; a retirement account can also be established by an individual. The contributions in this account are intended for use during retirement.

Employer Sponsored Retirement Plan

Many employers offer their employees participation in retirement plans that they sponsor. While a company can offer various types of retirement plans, the most common of these is a 401(k) plan.

Traditional 401(k)

A Traditional 401(k) plan is sponsored by an employer. This type of plan allows employees to contribute a portion of their paycheck into their 401(k) plan on a pre-tax basis. This plan is tax-deferred until the time of withdrawal. The plan may allow employer contributions, and is subject to annual nondiscrimination testing.

Roth 401(k)

A Roth 401(k) plan allows an employee to contribute amounts on an after-tax basis. This means that at the time of a qualified withdrawal, the contributions and earnings will be tax-free. This option is sometimes popular with younger workers with more time to accumulate compound interest or those currently in a higher tax bracket.

Safe Harbor 401(k)
This type of 401(k) retirement plan automatically exempts the plan from certain annual nondiscrimination testing. Employers must make employer contributions through a match or non-elective contribution to qualify for the safe harbor benefit.

Solo 401(k)
This is a 401(k) plan that covers a business owner (as well as their spouse) with no employees.

Types of IRAs

Traditional IRA
An IRA is an individual retirement account. This is an account that is opened by an individual and it is not tied to an employer. Contributions may be tax-deductible. The account holder pays taxes at the time of withdrawal.

Roth IRA
This is a type of individual retirement account where participants contribute to their account on an after-tax basis. The contributions are not tax deductible. The individual will not have to pay taxes on these funds at the time of a qualified withdrawal.

Components of a Retirement Plan

Automatic Enrollment

Some employers choose to automatically enroll their employees into a retirement plan. However, employees have the option to opt-out at any time, though they normally do not. Companies that choose to automatically enroll their employees into a retirement plan have shown higher participation rates than employers that do not.

Nondiscrimination Testing

Non discrimination testing ensures that plan contributions and assets are distributed proportionally when comparing highly compensated and key employees against non-highly compensated and non-key employees.

Top Heavy Testing

A plan becomes top heavy when owners and highly compensated employees own more than 60% of plan assets. This is tested annually based on account balances from the previous plan year.

Deferrals

A deferral is the amount of an employee’s paycheck that is directed to their retirement account.

Employee Contribution Limits

Employees can only contribute a certain amount to their retirement plan each year. Depending on the type of account, these employee contribution limits vary. As of 2023, the 401(k)contribution limit is $22,500. IRA accounts have a contribution limit of $6,500. Catch up limits can apply to individuals attaining age 50, allowing an additional contribution amount.

Employer Matching

An employer can match a certain percentage of an employee’s salary contributions to their company-sponsored 401(k) account. The maximum amount an employer will contribute is the employer’s decision.

Required Minimum Distributions (RMD)

The IRS requires plan participants who are no longer employed by the employer and are not 5% or more owners of the business to take minimum distributions beginning at the age of 73 as of 2023. RMDs are also required from Traditional IRAs, but not Roth accounts.

Vesting

When you are fully vested, you have 100% ownership of employer contributed amounts in your retirement account. A vesting schedule can vary from 100% immediate vesting up to a 6 year graded schedule. . This means after a certain number of years employed with the company, you will vest, or own, a certain percentage of your employer contributions. If you leave your employer before you are 100% vested, you forfeit the right to unvested amounts.

Employee Retirement Income Security Act (ERISA)

ERISA is the federal law for employers who offer a retirement plan. The Employee Retirement Income Security Act details the minimum standards that employers have to their retirement plan participants and beneficiaries.

Individuals Connected to the Plan

Fiduciary

Fiduciaries are responsible for handling plan funds and assets as well as acting in the best interest of all plan participants and beneficiaries. Some of their duties include:

• Managing plan assets
• Interpreting plan documents
• Selecting the plan investments

Highly Compensated Employee

An employee is considered a highly compensated employee (HCE) if they earn $150,000 or more in 2023 ($135,000 in 2022), or owns 5% or more of the sponsoring company in the current or preceding year. The compensation amount is determined annually by the IRS and indexed for inflation.

Non-Highly Compensated Employee

A non-highly compensated employee, (NHCE), does not meet the ownership or compensation requirements set forth by the IRS.

Key Employee

A key employee is one of the following:

• Makes $215,000 or more in 2023 ($200,000 in 2022), or
• Owns at least 5% of the business, regardless of their compensation, or
• Owns more than 1% of the business and has compensation exceeding $150,000 per year

Additional Retirement Plan Terms

Asset Allocation

The process of determining which asset class to place funds into. Some of these asset classes include:

• Stocks
• Bonds
• Cash reserves

Compound Interest

This occurs when a principal investment has a positive investment gain added to the principal amount in order to accrue additional returns.

Hardship Withdrawal

A hardship withdrawal allows you to withdraw funds from your account for certain circumstances before retirement. Some qualifying circumstances include:

• Purchasing your first home
• Paying for certain medical expenses
• Paying for certain funeral expenses
• Payments to prevent eviction
• Paying tuitionThough these circumstances exist, you will still be required to pay taxes on your withdrawal as well as an early withdrawal penalty of 10% unless you qualify for an exemption.

Mutual Fund

This investment is a diversified portfolio of stocks, bonds or other securities that are managed by a fund manager. Mutual funds offer a variety of investment strategies and styles.

Profit Sharing

Employers may make tax deductible contributions to employee 401(k) accounts, which result in benefits for both the employee and the employer. This can also be thought of as a type of bonus for employees.

Rate of Return

A rate of return measures the total loss or gain of an investment over time. Your calculated rate of return illustrates the growth or losses of your investments over a specified time period.

Rollover

An employee with a distributable event can roll their 401(k) account from one employer’s 401(k) plan to another or to an individual retirement account (IRA). Certain types of distributions cannot be rolled into another qualified plan.

State-Mandated Retirement Savings

In certain states, businesses are required to provide their employees with a retirement plan option, or enroll them into a state-administered program, which is typically a Roth IRA. Noncompliance with the state’s mandate can result in fines or penalties.

Form 5500

Employers offering a retirement plan must file a document called Form 5500 with the Department of Labor (DOL) annually. This document details the company sponsored retirement plan offered.. Form 5500 must also detail plan characteristics and financials such as:

• Information about the plan sponsor and administrator
• Number of active participants
• Number of retirees
• Plan funding information
• Fiduciary bond information

Businesses with more than 100 employees must also provide a detailed report from a plan audit while businesses with less than 100 employees typically file a shorter version of Form 5500.

Conclusion

We understand the terminology surrounding your retirement plan options can be difficult to digest. While this list does not encompass all the terms that exist, we hope that this list will help to prepare you for your initial retirement plan setup process. If you still have questions or concerns about your retirement plan options, don’t hesitate to contact our knowledgeable professionals today.

This content is for educational purposes only, is not intended to provide specific legal or financial advice and should not be used as a substitute for the legal advice of a qualified attorney or financial professional. The information may not reflect the most current legal developments, may be changed without notice, and is not guaranteed to be complete, correct, or up to date.