- Offering a 401(k) plan allows your employees to save for retirement and provides tax incentives for your business.
- Small businesses often see 401(k) plans as a significant expense, but there are opportunities to keep costs down by outsourcing work or using specialized software.
- Before offering a 401(k) plan, you must decide how you will administer it.
- This article is for small business owners and human resources professionals who are thinking about offering or expanding their 401(k) benefits.
Offering a 401(k) plan for your employees is a significant step for any small business owner. However, starting a retirement plan can be a daunting task and a significant expense, especially for very small businesses. This guide will explain some of the advantages of offering a 401(k) and help you get started in providing this benefit to your employees.
What is a 401(k) plan?
A 401(k) plan is an employer-provided benefit that allows employees to save money for retirement. Usually, employees select the types of investments for these funds. A 401(k) provides financial benefits to all members of the company, including the owner, and is highly sought after by employees.
Employees keep all of their contributions regardless of whether they leave the company, but employer matches are typically vested over several years.
Key takeaway: A 401(k) is a plan that allows employees to contribute a portion of their wages, and allocate it to certain investments, to save for retirement.
How do 401(k) plans work?
Setting up a retirement savings plan requires careful planning. For example, you must determine who is eligible to participate and select the right investment options for the money. There are numerous employee retirement plan providers that can help you with these tasks. [Looking for an employee retirement plan provider? Check out the employee retirement plans we think are best.]
When enrolled in a 401(k) plan, employees set a designated amount they want to be deducted from their paycheck each pay period. This contribution – which is excluded from taxable income, except in the case of Roth 401(k) plans – is automatically withdrawn from their paycheck and invested into a retirement account. The account is made up of investments – typically stocks, bonds and mutual funds – that employees can usually select themselves.
There is a cap on how much an employee can contribute each year. This limit varies depending on the plan type and the employee's salary, and it can also change as a result of government regulations. For example, the maximum contribution for a 401(k) plan in 2021 is $19,500, according to the Internal Revenue Service (IRS). Employees over age 50 can "catch up" and contribute an additional $6,500 to their 401(k) in 2021.
In addition, employers may elect to match a percentage of employees' contributions, up to a certain amount or percentage of their salary. For example, an employer might match 50% of an employee's contribution, not to exceed 6% of the employee's pay.
Typically, an employee must stay with the company for a certain number of years to keep the employer's contributions if the employee leaves the company. Employees usually gain ownership of employer contributions over a vesting schedule. For example, employees may be entitled to 20% of employer contributions after two years with the company, 40% after three years, 60% after four years, 80% after five years and 100% after six years.
Key takeaway: A 401(k) plan automatically takes money from the enrolled employee's check and invests it in a retirement plan made up of stocks, bonds and mutual funds. Employers may choose to match employee contributions as an additional perk.
Editor's note: Need an employee retirement plan for your business? Fill out the below questionnaire to have our vendor partners contact you with free information.
Types of 401(k) plans
There are two major types of 401(k) plans: traditional and Roth.
A traditional 401(k) plan allows employees to contribute a portion of their wages before taxes are taken out of their paychecks. Taxes aren't paid on those funds until they are withdrawn after retirement age, which is defined as 59 1/2 years old. There is a significant tax penalty if you withdraw money before reaching retirement age.
There are several traditional 401(k) plan types, including a standard profit-sharing plan, a safe-harbor plan that requires employers to contribute to accounts, and SIMPLE 401(k) plans targeted to businesses with fewer than 100 employees.
With a Roth 401(k), by contrast, contributions are taxed as they are made to the account. When the account holder reaches retirement age, also defined as 59 1/2 years old, they can generally make tax-free withdrawals from Roth accounts. Withdrawals made earlier, however, are subject to an early-withdrawal penalty and taxes.
Key takeaway: There are two main types of 401(k) plans: traditional and Roth. There are also plan subtypes, including programs tailored to small businesses.
How much does a 401(k) plan cost a business?
The cost of a 401(k) plan depends on many factors, including the following:
- Administrative costs. A plan administrator, a compliance professional or a benefits manager may be required to ensure your small business 401(k) plan runs smoothly, the proper amounts are withheld, and the correct tax records are kept and filed. You can expect to pay yearly administrative fees of $750 to $3,000.
- Employer matches. You'll need to consider the cost of matching employees' contributions, if that's an additional benefit you will offer. Those costs will depend on how many employees participate in the plan and how much they contribute.
- Software. For small businesses on a budget, there are 401(k) plan software platforms that can help you manage the program.
- Other fees. There may be costs associated with starting the 401(k) plan, or additional fees for adding certain benefits.
Key takeaway: The cost of a 401(k) plan depends on many factors, including how many employees the company has, how the plan is administered and how much employers provide in matching contributions.
Why you should offer a 401(k)
Although 401(k) plans aren't required by law in the U.S., they are beneficial for other reasons. Here are some of the benefits of offering a 401(k):
It attracts top talent. Many employees look for retirement options as one of the primary benefits when deciding where to work. The best job applicants in their field have choices of where to work, so offering a 401(k) can help your business attract and retain top talent. Not offering such an important benefit means top applicants may overlook your company for a competitor.
It increases job satisfaction. Employees are happier when they know you're looking out for them, and providing a retirement plan is one way to show you value your employees. Happier employees tend to be more productive and stay with your company longer, thus reducing costly turnover.
It offers tax advantages. Your business also may benefit from tax incentives. The SECURE Act of 2019 allows businesses with up to 100 employees to claim their plan setup costs as a tax write-off. Additionally, employer contributions to a 401(k) plan may be tax-deductible.
Key takeaway: Small business 401(k) plans can help you attract and retain top talent, increase employees' job satisfaction and provide tax savings for your business.
Tips for implementing a 401(k) plan
If you decide to offer a 401(k) plan, consider the following advice:
Consider outsourcing the administration.
Bringing in an in-house expert can be very costly, and to do so without experienced personnel could lead to mistakes or inefficiencies. By outsourcing, you improve efficiency and reduce liability.
Professional employer organizations (PEOs) are third-party companies that handle human resources, payroll, benefits and 401(k) plans for small businesses. Thousands of small businesses nationwide partner with PEOs to get access to competitive benefits and 401(k) plans. Choosing a PEO can be complicated, but there are several types that make sense for a variety of small businesses. The best PEOs have industry accreditation, minimal requirements for coverage and great features, like short-term contracts.
Provide competent, qualified financial advisors.
It is very beneficial for your employees to have someone to consult when they have questions about how to invest in their account and how much they should contribute. It also takes this burden off you. Be sure to properly vet your applicants for the financial advisor position, because poor financial advice can have serious financial and legal consequences.
Provide good investment options.
Ensure your company offers a good range of investment options. Your mutual-fund options should represent different markets, such as U.S stocks, international stocks and bonds. A good rule of thumb is that 75% of your mutual funds should have an expense ratio of less than 1%. Also, keep track of how the funds in your plans are doing, to see whether they are underperforming, matching or outperforming their benchmarks. You want to ensure your employees are happy with the options available to them. It should be free and simple to swap fund options.
Key takeaway: To run your 401(k) program in a compliant, budget-friendly manner, consider outsourcing benefits administration, provide reliable consultants and offer good investment options.
PEO Providers that offer retirement
PEO providers that offer health benefits
|Best Technology Platform|
|Rippling PEO Review||Best Scalable PEO|
|TriNet PEO Review||Best PEO With Tailored Plans|
|ADP TotalSource Review||Best Customer Service|
|Oasis Review||Best for Startups|
|Insperity PEO Services Review||Best SMB Resources|
What are the best small business 401(k) options?
Not every 401(k) plan is built for large corporations. As a small business owner, you have options for plans that fit your budget and business goals. Here are some of the employee retirement plan providers we selected as our best picks:
Guideline is a top employee retirement plan provider that handles all of your plan needs, including plan administration, investment management and recordkeeping. The company charges a monthly base fee and a per-participant fee.
ShareBuilder 401k is a great option for employers that are looking to offer a safe-harbor 401(k) plan. The company provides small businesses with a plan administrator, custodian, investment advisor and recordkeeper. Contracts are not required, so you can cancel at any time.
Vanguard is recommended for entrepreneurs who want a solo 401(k) plan. There are no setup fees, and you can choose from more than 100 investment options. The company's website includes a selection of tools to help you decide where to invest your money.
Key takeaway: There are many qualified employee retirement plan providers, and we recommend Guideline, ShareBuilder 401k and Vanguard.
Additional reporting by Shimon Brathwaite.