Certified Plan Sponsor Professional (CPSP) Practice Exam

When calculating contributions for a 401(k), which factor is considered?

1. Only the employee's salary

2. 25% of total compensation of all eligible participants

3. The number of dependents the employee has

4. Only the vested portion of contributions

The correct answer is: 25% of total compensation of all eligible participants

The correct choice reflects a common consideration in 401(k) contributions regarding the contribution limits set by the IRS. Specifically, when determining how much an employer can contribute to a 401(k) plan, a general guideline is that the total contributions cannot exceed 25% of the eligible participants' total compensation, including both employee and employer contributions. This is vital for ensuring compliance with tax regulations that govern retirement plans. In practice, while individual contributions are based on each employee's salary or payroll, employer contributions can also consider the broader context of the group's total compensation to cap contributions appropriately. This understanding is crucial for plan sponsors who manage retirement plans and must adhere to regulatory limits to avoid penalties. The remaining options do not capture the primary factor considered when calculating contributions for a 401(k). For instance, focusing solely on an employee's salary ignores the implications of pooled contributions across all eligible participants. Similarly, the number of dependents is unrelated to contribution limits, and only accounting for the vested portion neglects the overall accumulation and growth of the retirement plan, which is also a critical aspect of 401(k) contributions.