How to Set Up a 401(k) Plan
for Small Business Employees
Driven by retention and recruiting pressures, the need for small business 401(k) plans is shifting from “want-to” to a “need-to.” The suitable workplace retirement benefit plan for your small business gives you an upper hand in competitive job markets and helps your staff. As top candidates weigh the advantages and disadvantages of different employment opportunities, offering a 401(k) plan is among the best ways to help your business attract and retain key talent. Additionally, tax benefits and owner retirement savings options make setting up a 401(k) plan a smart benefit.
Let’s dive into the advantages of establishing a retirement program at your business, and how you can make setting up a 401(k) plan for your employees a breeze.
Who does what?
Before we dive into the details on what needs to take place, let’s quickly talk through the supporting players that can assist you with plan installation and ongoing maintenance/compliance.
Retirement Plan Specialist (aka Third-Party Administrator or TPA): The retirement plan specialist is your primary resource for tailoring the features and provisions you will include in your new 401(k) plan. Plan design includes when employees will become eligible, the types of contributions that can be allowed, when employees can access their money, and so on. A good retirement plan specialist will take the time to help you understand your options and select the design features that best suits unique your organization and demographics. After the plan is established, the retirement plan specialist will perform the annual compliance testing, calculate any company match or profit sharing contributions you might want to make and prepare the necessary annual government filings, including IRS Form 5500 annual return/report.
Investment Advisor: The investment representative will help you select and monitor the investment funds that will be available to the employees in your plan. The advisor will also hold enrollment education meetings with your employees and answer their investment questions. They will also help benchmark your plan for competitive fees.
Recordkeeper: This is where your HR or payroll provider will submit employee and employer contributions, if any, to be deposited and invested. The recordkeeper tracks assets in your retirement plan – more specifically, how much money belong to each of your employee. They also maintain a website so your employees can check their 401(k) balances at any given time, provide retirement calculators and guidance, print and mail statements to your employees and maintain toll-free customer service lines for plan participants, among others.
Engaging a solid team of service providers can take much of the burden off your shoulders and ensure you are getting expert guidance – now and going forward.
American workers love their 401(k) plans and appreciate features they offer.
Most defined contribution account-owning households agreed that employer-sponsored retirement accounts helped them “think about the long term, not just my current needs” (91 percent), and that “payroll deduction makes it easier for me to save” (92 percent). And, 82 percent of households with plan accounts agreed that the “tax treatment of my retirement plan is a big incentive to contribute.”1
What are the advantages of sponsoring an employee 401(k)?
- Small businesses that start a new plan can claim up to $5,000 per year for the first three (3) years, thanks to the SECURE Act that was passed into law in Dec. 2019.
- Plan administrative expenses are tax-deductible, along with, of course, employer contributions such as a match or profit-sharing.
- Technology improvements in payroll integration and recordkeeping enable implementation and maintenance of offering a retirement plan more affordable than ever.
What are the advantages of a 401(k) plan vs. other retirement options?
When compared to other retirement options (SIMPLE IRA, SEP IRA, and profit sharing), the benefits of a 401(k) retirement plan include a broad range of advantages for both employers and employees. Along with a vesting schedule to incentivize retention, both business owners and employees can benefit from:
Tax-deferred retirement saving: With a 401(k), employees can save upfront with pre-tax dollars while they are working. Employee Roth after-tax contribution is also an option. By the time they need their savings to fund their retirement, they will likely be in a lower tax bracket, which can generate long-term tax savings.
Employer match: Matching contributions are among the top benefits of 401(k) plans for employees. Employers can either match a percentage of employee contributions up to a set portion of total salary, or contribute up to a certain dollar amount, regardless of employee salary.
Defrayed 401(k) start-up costs: Eligible employers may be able to claim a tax credit of up to $5,000 for the first three years to pay for associated costs of starting a qualified plan such as a 401(k) for employees. Claiming the credit requires completing Internal Revenue Service Form 8881, Credit for Small Employer Pension Plan Startup Costs. This is where your CPA comes into the picture.
How to set up a 401(k) plan for your staff
The process of how to set up a 401(k) plan for your small business is not much different to making other important decisions. You’ll need to do your research, make decisions based on your findings and then take appropriate action.
Explore retirement options for your organization
It’s important to do your due diligence in researching firms that provide recordkeeping and third-party administration services for 401(k) plans. As you get your ducks in a row, include a range of established, reputable mutual fund companies, brokerage firms and insurance companies. Look for providers that can serve you and your employees long-term with extensive resources and excellent customer service.
You may also want to hear from owners of businesses that are similar to yours, as they may be able to offer insights from their own experiences selecting 401(k) plan service providers.
Select a plan for your employees
Once you’ve chosen a retirement services provider, it’s time to decide on a plan that fits both your business and your employees’ needs. Options available to employers regardless of size, including businesses with only one employee, include:
1. A traditional 401(k) plan, which is the most flexible option. Employees are able to contribute up to the IRS limit. And employers can, but are not required to, make matching or profit sharing contributions to employees.
2. The safe harbor 401(k) plan, which has several variations and requires the company to make a required contribution to the plan participants. These required contributions benefit the company, the business owner and key employees How? By giving them greater ability to maximize salary deferrals.
3. An automatic enrollment 401(k) plan, which permits you to automatically enroll employees and put deductions from their salaries in certain default investments, unless employees elect otherwise. This feature persuades workers to participate in the company 401(k) plan and increase their retirement savings, which also benefits business owners. Automatic enrollment plans may also contain a safe harbor provision.
How to set up a 401(k) for a small business
Setting up a 401(k) for your small business includes some crucial steps, some of which can (and should be) be outsourced. It’s important to remember that the employer maintains a fiduciary duty to ensure that the plan acting in the best interest of the participants. The U.S. Department of Labor (DOL) provides in-depth details of the process:
1. Design your new plan
401(k) plan design refers to how your plan is tailored and what features they will include. There’s no such as thing “one size fits all” 401(k) plan. Good plan design matches plans specifications to employer goals and employee demographics. Employer goals for a retirement plan can vary greatly. Some employers may want to maximize owner contributions at the lowest overall cost, while others want to incentivize employee participation in their plan. Basically, there are six major plan design features – eligibility, compensation, contributions, vesting, withdrawals, and loans. A quality retirement plan expert will take the time to understand your needs and walk you through the process – answering any questions you might have about your options and helping you choose the best features based on your organization’s goals and budget.
2. Create a 401(k) plan document
Create a plan document that complies with IRS Code and outlines the details of your retirement plan. Set up procedures to ensure the document is followed.
3. Set up a trust with a recordkeeper to hold the plan assets
A plan’s assets are required to be held in trust to ensure the funds are used solely to benefit the participants and their beneficiaries. Look for a recordkeeper that provides a user-friendly website and excellent customer service. Ideally, employees should be able to login to their accounts 24/7 and view their contributions, make deferral elections, and request a withdrawal or loan.
4. Provide information to plan participants
You’re required to provide certain information to plan participants about plan benefits, rights and features. You must also provide a summary plan description (SPD) to inform participants and beneficiaries about the plan and how it operates. On an ongoing basis, you must also provide information to keep plan participants updated on investments and changes (financial institutions may provide this as well, and can serve as a resource for employees). The fees associated with the account must be communicated to participants as well, and a disclosure form can help ensure your communication follows IRS requirements.
How much should an employer contribute to the plan?
The amount you as a plan sponsor decide to contribute is completely up to you. As you make this decision, consider the tax savings you can receive for making employer contributions. Employer matching contributions are tax-deductible on federal corporate income tax returns, and some administrative fees associated with managing a 401(k) plan are tax-deductible as well.
You can match as much as you want as long as it stays within the IRS limitations, which combine both employer and employee contributions. According to the IRS, this combined total is the lesser of 100 percent of an employee’s compensation or $61,000 for 2022, or $67,500 for employees age 50 or older.
Also consider factors such as the positive impact a matching contribution can have on employee morale and worker retention strategies. Given the steep costs of hiring and training new employees, an employer match offers the opportunity to truly invest in your workforce. These considerations may help guide your decisions about how much to contribute to the 401(k) plan.
How much should employees put away?
Like the employer, employees are free to contribute as much as they like to the plan, within IRS limitations. For 2022, employees can put away up to $20,500, plus a $6,500 catch-up contribution if 50 and older. Consider ways to help employees improve their financial wellness and increase their 401(k) participation. Doing so could benefit your business in the form of happier, less-stressed employees who are more engaged and productive.
How much does a start-up 401(k) cost for a small business?
Fees to set up a 401(k) plan will vary depending on the size of your business and the types of benefits you select. Initial setup fees can generally run anywhere from $2,000 to $3,000, depending on the chosen retirement service provider. Other costs to consider are recordkeeper fees and initial consulting costs for investment advice.
What are the upkeep costs for a start-up 401(k)?
Once you install a 401(k), your business will have ongoing costs in the form of administrative fees and any matching contributions. Fees generally fall into three categories: compliance administration and government filings, investment fees and individual participant service fees.
There are also potentially fees or penalties associated with being non-compliant with the 401(k) rules and regulations, which you’ll want to avoid whenever possible. A few examples of 401(k) penalties include:
- Non-compliance with ERISA for failing to meet certain filing and notification requirements.
- Failing to file Form 5500 with the IRS each year.
- Failing to deposit employee contributions in a timely manner.
Best way to avoid fines and penalties? Working alongside a seasoned retirement plan specialist that can help ensure compliance when it comes to retirement plan government forms, deadlines and notifications.
How long does it take for a small business start-up 401(k) to go live?
Establishing a 401(k) can be a fairly straightforward process. However, without due diligence, that approach would be reckless and make your business vulnerable to expensive fees and risks associated with making hasty decisions regarding something as important as selecting a trustee. Depending on how much preliminary research you do, allow yourself ample time to create a plan document, establish a trust, notify employees and launch your new benefit.
Administering workplace 401(k) plans for a small business
Setting up a 401(k) can be complicated, but you don’t have to go it alone. Engage a retirement plan specialist with an excellent track record that can help you get the ball rolling, oversee your plan and even offer ideas and guidance to maximize the value to you and your employees. Doing so can go a long way in ensuring an ongoing, positive benefit for years to come.
Find the Right Plan for Your Business or Nonprofit
NESA Plan Consultants (NESA) is a retirement plan provider working with advisors, recordkeepers and CPAs to offer customized 401(k), 403(b) and 457(b) plans. NESA offers modern solutions and provides resources to employers and employees to secure a brighter financial future.