As a small business owner, attracting and retaining the right people is essential for growth. Offering competitive benefits is a part of that equation, and a 401(k) plan supports your employees’ long-term financial security. While it may seem like a feature for large corporations, establishing a retirement plan is an achievable goal for a business of any size. This guide provides a path to understanding your options and implementing a plan.
Why a Small Business Should Offer a 401(k)
Offering a 401(k) plan is a strategic decision that enhances your ability to compete for skilled professionals. In a competitive labor market, a benefits package can be the deciding factor for a candidate. It demonstrates a commitment to your employees’ long-term welfare, which can foster loyalty and reduce turnover. Employees also value saving for retirement directly through payroll deductions.
Beyond talent management, there are tax advantages for your business. Company contributions to employee accounts are tax-deductible, and administrative costs can be deducted as a business expense. Tax credits are also available for small businesses to offset the initial expenses of starting a plan. These credits can cover a significant portion of setup and administration costs for the first three years, with an additional credit available for employer contributions.
Types of 401(k) Plans
Several 401(k) options are designed to meet the needs of small businesses. The best choice depends on your company’s size, budget, and administrative capacity.
Traditional 401(k)
The Traditional 401(k) offers the most flexibility. You can decide whether to contribute to your employees’ accounts through matching, non-elective contributions, or both. Employer contributions can also be subject to a vesting schedule, meaning an employee gains full ownership over time. This flexibility requires annual nondiscrimination testing to ensure the plan does not unfairly favor highly compensated employees.
Safe Harbor 401(k)
A Safe Harbor 401(k) is a popular choice for businesses that want to avoid annual nondiscrimination testing. To qualify, you must make a mandatory, fully-vested contribution to employee accounts. This can be a dollar-for-dollar match on the first 3% of compensation plus a 50% match on the next 2%. Another option is a non-elective contribution of at least 3% of compensation for all eligible employees.
SIMPLE 401(k)
Designed for businesses with 100 or fewer employees, the SIMPLE 401(k) is a straightforward option exempt from nondiscrimination testing. In exchange, employers must make contributions that are immediately 100% vested. You can either match employee contributions dollar-for-dollar up to 3% of their compensation or make a 2% non-elective contribution for all eligible employees. These plans have lower contribution limits for employees compared to other 401(k) types.
Solo 401(k)
The Solo 401(k) is exclusively for self-employed individuals or business owners with no employees other than a spouse. This plan allows the owner to contribute as both the “employee” and the “employer,” enabling significantly higher contribution amounts. As the employee, you can make elective deferrals up to the annual limit. As the employer, you can contribute a percentage of your compensation.
The Step-by-Step Setup Process
Once you have decided which type of 401(k) best suits your business, the next phase involves setting up the plan’s legal and financial framework.
First, select a 401(k) provider. You can choose from financial institutions, insurance companies, payroll providers, and fintech firms. Compare providers based on their service models, fee structures, and investment options to find the right partner.
With a provider chosen, you will adopt a written plan document. This legal document outlines all the plan’s rules, including eligibility and contribution limits. You must also set up a trust to hold the plan’s assets, which legally separates them from your business’s assets.
The final steps are establishing a recordkeeping system and communicating the plan to your employees. Your provider will handle tracking contributions, earnings, and investments for each participant. You must provide eligible employees with a summary plan description and information on how to enroll, choose investments, and name beneficiaries.
Understanding the Associated Costs
Offering a 401(k) involves several types of fees, which can be grouped into three main categories: setup, administration, and investment fees.
Setup fees are a one-time cost charged by the provider to establish the plan. This fee covers the creation of the plan document and the work involved in getting the plan operational.
Ongoing administration and recordkeeping fees pay for the day-to-day management of the plan, including transaction processing and compliance testing. They are often structured as a base fee plus a per-participant fee or as a percentage of total plan assets.
Investment fees, often called expense ratios, are charged by the mutual funds or other investment vehicles offered within the plan. These fees are not billed directly to you but are taken from the investment returns of the plan participants.
Your Fiduciary Responsibilities
When you offer a 401(k) plan, you take on the role of a fiduciary. This legal duty requires you to act solely in the best interests of plan participants and their beneficiaries. This responsibility requires a high standard of care in managing the plan and its assets.
Your core duties include selecting and monitoring plan investments, ensuring they are diversified to minimize the risk of large losses. You must act prudently, meaning with the skill and care a knowledgeable person would use in a similar situation. This standard applies to every decision you make for the plan.
You are also required to follow the terms of your written plan document. Any deviation from the rules can lead to compliance issues. You must also monitor service providers to ensure they perform their duties effectively and that their fees are reasonable.
Common Alternatives to a 401(k)
If a 401(k) seems too complex or costly, simpler retirement plan options are available that still help your employees save. These alternatives often have lower administrative burdens and costs while providing tax benefits.
A popular alternative is the SEP IRA (Simplified Employee Pension). With a SEP IRA, only the employer makes contributions to a traditional IRA set up for each eligible employee. This simplifies administration and is well-suited for businesses with fluctuating cash flow, as you can decide how much to contribute each year.
Another option is the SIMPLE IRA (Savings Incentive Match Plan for Employees). This plan allows both employee and employer contributions but has simpler rules and lower contribution limits than a 401(k). Employers are required to make contributions, with a structure similar to the SIMPLE 401(k).