Offering a 401(k) Plan? Tips for Small Business Owners

• 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 thinking about offering or expanding their 401(k) benefits.

Offering a 401(k) plan for employees is a significant step for any small business owner. However, it 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) plan and help you get started 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 company members, including the owner, and is a highly sought-after employee perk.

Employees keep all their contributions even if they leave the company, but employer matches are typically vested over several years.

Key takeaway: A 401(k) plan 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?

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. Numerous employee retirement plan providers can help you with these tasks. 

Here are the essential elements of a 401(k) plan:

1. Contributions are deducted. When enrolled in a 401(k) plan, an employee designates an amount 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 This contribution – which is excluded from taxable income, except in the case of Roth 401(k) plans – is automatically withdrawn from their paycheck and placed into a retirement account. The account comprises investments – typically stocks, bonds and mutual funds – that employees usually can select themselves.

2. There's a contribution cap. 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 due to government regulations. For example, the maximum contribution for a 401(k) plan in 2022 is $20,500, according to the IRS. Employees over age 50 can "catch up" and contribute an additional $6,500 to their 401(k) in 2022.

3. Employer matching is possible. 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.

4. Vesting takes time. Typically, an employee must stay with the company for a certain number of years in order to keep the employer's contributions when they leave the company. An employee usually gains ownership of employer contributions over a vesting schedule. For example, an employee 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.

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Types of 401(k) plans

There are two primary 401(k) plan types: traditional and Roth. Let's examine how each type works. 

Traditional 401(k)

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, defined as 59.5 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 a SIMPLE 401(k) plan that is targeted to businesses with fewer than 100 employees.

Roth 401(k)

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 59.5 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, compliance professional or 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 a yearly administrative fee of between $750 and $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, 401(k) plan software platforms can help 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):

1. It attracts top talent. Many employees look for retirement options as part of a benefits package when deciding where to work. The best candidates can choose where they work, so offering a 401(k) can help your business attract and retain top talent. Not offering such a vital benefit means top applicants may bypass your company for a competitor.
   
   
2. 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 turnover.
   
   
3. 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 deduction. Additionally, employer contributions to a 401(k) plan may be tax-deductible.

Key takeaway: Small business 401(k) plans can help you attract top talent, improve employee retention, increase employees' job satisfaction, and provide tax savings for your business.

How to start offering a 401(k) plan

Once you've decided to offer an employee 401(k) plan, you'll need to follow certain steps for compliance. Here's what you'll need to do: 

1. Create and document a 401(k) plan.
2. Open a trust.
3. Establish a system to record employee contributions.
4. Update plan participants regularly.

1. Document the 401(k) plan.

The first step you'll need to take once you decide to offer your employees a 401(k) plan is to document the plan details. This process can be tedious, and small business owners often outsource this task. 

Your plan should include details about contribution amounts, when benefits are paid and eligibility information. Once you create the plan, you'll have to submit it to the IRS for approval. Also, remember to review this plan annually to remain in compliance. 

2. Open a trust.

Once your 401(k) plan has been approved, you'll need to set up a trust account where all plan assets will be held. At this point, you'll also need to select a trustee who can oversee all plan activities, including contributions and distributions.

3. Implement a recordkeeping system.

The next step is implementing a system to track plan values and employee contributions. If you need assistance with this step, consider hiring a recordkeeper. 

4. Update participants on plan changes.

The IRS requires all business owners to consistently update 401(k) participants on changes, investments and associated fees. Business owners are also required to provide employees with a summary plan description, including detailed information about how the plan operates.

Tips for implementing a 401(k) plan

If you decide to offer a 401(k) plan, consider the following advice.

1. 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 access competitive benefits and 401(k) plans. 

Choosing a PEO can be complicated, but several types make sense for small businesses. The best PEOs have industry accreditation, minimal requirements for coverage, and great features, including short-term contracts.

2. Provide competent, qualified financial advisors. 

It's 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. An advisor takes the burden of providing financial advice to your employees off of you. Be sure to properly vet your applicants for the financial advisor position, because poor financial advice can have serious financial and legal consequences.

3. 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 their options. It should be simple and free 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.

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 best employee retirement plan providers to consider for your small business.

Guideline

Guideline is a top employee retirement plan provider that handles all your plan needs, including plan administration, investment management and recordkeeping. The company charges a monthly base fee and a per-participant fee.

ShareBuilder 401(k)

ShareBuilder 401(k) is a great option for employers offering 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.

Paychex Employee Retirement

Paychex offers 401(k) plans that integrate with its HR, payroll and employee benefits services. Business owners can choose their own 401(k) plan, IRA, 403(b) and investment options to offer employees when partnering with Paychex. In addition, entrepreneurs can add their preferred financial advisor or plan design. Paychex makes it easy to set up your plan and integrate with automated payroll to handle employee enrollment and contributions.

Human Interest

Human Interest offers user-friendly 401(k) plans and provides cost-effective employee retirement options to small businesses. When partnering with Human Interest, entrepreneurs and their employees gain access to benefits plans that start at just $120 per month, plus $4 per employee per month, including full recordkeeping, administration tools, and seamless payroll integration.

American 401k

American 401k is a small retirement benefit services provider based outside Philadelphia that offers highly personalized service combined with the backing of a large national insurance company. Small business owners that want a no-frills, no-fuss employee retirement package can work with American 401k to design the perfect plan for their needs.

ADP Employee Retirement

ADP employee retirement benefits complement the company’s payroll services through an all-in-one platform. In addition, ADP provides employee retirement benefit accounts that are cost-effective and easy-to-use solutions for small businesses with at least a couple dozen employees.

Vanguard

Vanguard is best 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 various tools to help you decide where to invest your money.

PEO providers that offer retirement and health benefits

If you're looking to outsource your benefits administration, here are our reviews of several of the best PEOs that can help your business provide retirement and health benefits: 

Dachondra Cason and Shimon Brathwaite contributed to the writing and research in this article.