401(k) Plans: Eligibility, Rules, Limits & How They Work

Question 1 

Alison, Chung, and Chau are not eligible for the 401(k) plan. For a person to qualify for the 401(k), he or she must be age 21 years and have one year of service. Alison is19 years but meets the year of services qualifications; thus, he is not eligible for the 401(k) plan. Chung is 25 years old but has eight months of service; hence does not qualify for the plan because he does not meet the year of services qualification. Chau does not meet both age and year of service qualifications; henceforth is not eligible for the 401(k) plan. 

Question 2: High Compensated 

According to the 401(k) characteristics, shareholders are highly compensated when their ownership uses the top 20% election. Only Mark and Jeff are highly compensated because their ownership in the company is more than 20%. Mark owns 60% of voting rights, while Jeff owns 30% of the election. The other shareholders have less than 20 % ownership thus are not highly compensated. 

Question 3: Bubble’s profit contributions 

Profit-sharing contribution = 10% 

Contribution = Base salary x % Profit-sharing contribution 

EE#	Employee	Salary	Deferral	Base salary	Contribution
1	Mark	$ 200,000	$ 10,000	$ 190,000	$ 19,000
2	Jeff	$ 150,00	$ 15,000	$ 135,000	$ 13,500
3	Chad	$ 75,000	$ 5,100	$ 69,900	$ 6,990
4	Josh	$ 85,000	$ 0	$ 85,000	$8,500
5	Alex	$ 60,000	$ 4,500	$ 55,500	$ 5,550
6	Shay	$ 75,000	$ 0	$ 75,000	$ 7,500
7	Lisa	$ 50,000	$ 0	$ 50,000	$ 5,000
8	Alison	$ 60,000	$ 0	$ 60,000	$ 6,000
9	Chung	$ 24,000	$ 0	$ 24,000	$ 2,400
10	Chau	$ 18,000	$ 0	$ 18,000	$ 1,800
Total Contribution					$ 76,240

The most Bubble could contribute is $ 76,240 

Question 4: Actual Deferral Percentage for Highly compensated Employees 

Mark and Jeff are the highly compensated employees of Bubble LLC. The percentage deferral is computed as follows: 

Mark 

Deferral (%) = (Deferral amount/ salary) x 100% 

Deferral = $ 10,000 

Salary = $ 200,000 

Deferral (%) = ($ 10,000/$ 200,000) x 100% 

Deferral (%) = 0.05 x 100% 

Deferral (%) = 5% 

Jeff 

Deferral (%) = (Deferral amount/ salary) x 100% 

Deferral = $ 15,000 

Salary = $ 150,000 

Deferral (%) = ($ 15,000/$ 150,000) x 100% 

Deferral (%) = 0.10 x 100% 

Deferral (%) = 10% 

Question 5: Actual Deferral Percentage for Highly Non-compensated Employees 

Chad 

Deferral (%) = (Deferral amount/ salary) x 100% 

Deferral = $ 5,250 

Salary = $ 75,000 

Deferral (%) = ($ 5,250/$ 75,000) x 100% 

Deferral (%) = 0.07 x 100% 

Deferral (%) = 7% 

Josh 

Deferral (%) = (Deferral amount/ salary) x 100% 

Deferral = $ 5,100 

Salary = $815,000 

Deferral (%) = ($ 0/$ 85,000) x 100% 

Deferral (%) = 0.0 x 100% 

Deferral (%) = 0% 

Shay 

Deferral (%) = (Deferral amount/ salary) x 100% 

Deferral = $ 4,500 

Salary = $ 75,000 

Deferral (%) = ($ 4,500/$ 75,000) x 100% 

Deferral (%) = 0.06 x 100% 

Deferral (%) = 6% 

Alex 

Deferral (%) = (Deferral amount/ salary) x 100% 

Deferral = $ 0 

Salary = $ 60,000 

Deferral (%) = ($ 0/$ 60,000) x 100% 

Deferral (%) = 0.0 x 100% 

Deferral (%) = 0% 

Lisa 

Deferral (%) = (Deferral amount/ salary) x 100% 

Deferral = $ 0 

Salary = $ 50,000 

Deferral (%) = ($ 0/$ 50,000) x 100% 

Deferral (%) = 0.0 x 100% 

Deferral (%) = 0% 

Alison 

Deferral (%) = (Deferral amount/ salary) x 100% 

Deferral = $ 0 

Salary = $ 60,000 

Deferral (%) = ($ 0/$ 6,000) x 100% 

Deferral (%) = 0.0 x 100% 

Deferral (%) = 0% 

Chung 

Deferral (%) = (Deferral amount/ salary) x 100% 

Deferral = $ 0 

Salary = $ 24,000 

Deferral (%) = ($ 0/$ 24,000) x 100% 

Deferral (%) = 0.0 x 100% 

Deferral (%) = 0% 

Deferral (%) = (Deferral amount/ salary) x 100% 

Deferral = $ 0 

Salary = $ 18,000 

Deferral (%) = ($ 0/$ 18,000) x 100% 

Deferral (%) = 0.0 x 100% 

Deferral (%) = 0% 

Question 6: ADP Test 

EE#	Employee	Salary	Deferral	ADP
1	Mark	$ 200,000	$ 10,000	5%
2	Jeff	$ 150,00	$ 15,000	10%
HCE Averages				7.5%
3	Chad	$ 75,000	$ 5,100	7%
4	Josh	$ 85,000	$ 0	0
5	Alex	$ 60,000	$ 4,500	6%
6	Shay	$ 75,000	$ 0	0
7	Lisa	$ 50,000	$ 0	0
8	Alison	$ 60,000	$ 0	0
9	Chung	$ 24,000	$ 0	0
10	Chau	$ 18,000	$ 0	0
Non-HCE Average				6.5%

Explanation 

According to the result, the ADP test did not pass. The highly compensated employees earn huge salaries and have relatively low deferral salaries, while the highly non-compensated employees earn low salaries but have high deferral salaries, and some highly non-compensated employees have zero deferral salaries. Bubble LLC should ensure the highly non-compensated employees have deferral salaries to pass the ADP test. 

Question 7: Mark's contribution to the plan 

Contribution = profit-sharing contribution (%) x salary 

Salary =$ 200,000 

Profit-sharing contribution = 10% 

Contribution to the plan = $ 200,000 x 10% 

Contribution to the plan = $ 20,000 

Suppose the company decides to integrate a profit-sharing contribution with that of the social security wage base. In that case, Mark's contribution to the 401(k) plan will be $ 20,000 regardless of the deferral salary. 

Question 8: Allison’s year of Investment 

Allison has two years of service currently for the purpose of investing. 

References 

VanDerhei, J., Holden, S., Alonso, L., & Bass, S. (2018). 401 (k) plan asset allocation, account balances, and loan activity in 2016.  EBRI Issue Brief , (458).