What Small-Business Owners Need to Know About Offering a 401(k)


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By Melissa Darcey

Defined contribution plans—including 401(k) plans—are the most popular type of retirement plan sponsored by employers. More than 500,000 401(k) plans are currently offered in the U.S., and the number is growing. Ten years ago, they were considered a luxury, but today’s changing economy is transforming the 401(k) into one of the most important financial terms a small-business owner should know.

Building a plan for your business is a significant undertaking. Whether you’re about to start a retirement program or just started considering one, review this helpful guide first.

The Most Common 401(k) Terms

The best way to understand a 401(k) is to speak its language. There are dozens of terms associated with retirement plans, but here are a few of the essentials.

  • Plan sponsor. Your business is the plan sponsor since it is offering the 401(k) to your employees.
  • Plan participant. Anyone who opens an account and contributes to one is a plan participant.
  • 401(k) match. Some employers choose to match employee contributions to help them increase their plan savings. A common employer match is offering $0.50 for every $1 an employee contributes. Most often, companies limit the match to 3% of the employee’s total salary.
  • Traditional 401(k). Contributions to a traditional 401(k) are made on a pre-tax basis. You receive a tax break upfront, but you have to pay taxes when you access the account in retirement.
  • Roth 401(k). Contributions to a Roth 401(k) are made with after-tax dollars. You don’t receive a tax deduction upfront, but your money is tax-free when you retire and tap the account.
  • Annual contribution limits. Whether you have a Roth or traditional 401(k), you can contribute only up to $18,000 per year, as of 2016.
  • Catch-up contribution. If you are over the age of 50, you are allowed to contribute an additional $6,000 per year.

The Benefits of a 401(k)

Like health insurance, 401(k) plans are one of the most valuable benefits you can offer your employees—and sponsoring a plan offers advantages for both you and your employees.

  • You can improve employees’ retirement readiness. You want to see your employees succeed and retire at the right time for them—not their wallets. Helping them prepare for retirement means they’re likely to experience less stress and retire on schedule, rather than continue working for the sake of a paycheck.
  • You can increase retention and give your business a competitive advantage. Many small businesses can’t compete with large corporations regarding salaries and perks. But offering a valuable benefit, such as a 401(k), can help you retain more employees and help you stand out from other small companies.
  • You can save more for your retirement. Employers can also reap the rewards of a company-sponsored 401(k). Open an account and contribute annually to jumpstart your own retirement savings.
  • You’re eligible for tax breaks. 401(k) plans offer tax credits and deductions for businesses, including a first-time buyers tax credit for starting a plan, deductions for any employer matches you offer, and deductions for contributions made to your personal account.

The Downsides of a 401(k)

While many large companies offer 401(k) plans, only around 45% of businesses with fewer than 100 employees offer one. One reason why is that starting a retirement plan can be a time-consuming and daunting task.

  • There can be high fees. 401(k)s have complex fee structures, which makes it hard to compare plans and evaluate actual costs. Along with the expenses of setting up a program, you’ll also face recordkeeping fees, investment consulting fees, revenue sharing fees, and more.
  • There are legal risks involved. If you exercise control of your plan’s management, you are required to act as a fiduciary, meaning your decisions must be made solely in your employees’ best interests. You must maintain in-depth records to show your management of fees and investments offered.
  • You have to stay up-to-date on changing laws. The financial services industry is always evolving and adjusting its regulations. If you choose not to work with an advisor or retirement plan consultant, you’ll be responsible for keeping your plan compliant and updated.

The Must-Have Plan Features

Not all 401(k) plans for business owners are created equal. There are a few important features to look for to help ensure you get a plan with the greatest value and performance.

  • Low-cost investment options. The less you pay in fees, the more you and your employees can save. When comparing plan providers, avoid plans with fees higher than 1%. This number includes all fees—such as recordkeeping, custodial, and other management costs—not just the fund expenses.
  • Minimal administrative costs. Plans usually include a one-time setup fee and an annual fee for ongoing management. These costs can add up to thousands of dollars, so shop around and compare before choosing a plan.
  • A variety of investment options. Make sure your plan offers diverse investment options to meet different participants’ risk tolerance and goals. Older employees will likely choose conservative options, whereas younger investors can take more risks.
  • A consultant you trust. Most business owners don’t have the time to manage their company’s retirement program. You can save time and minimize your risk by choosing a provider or working with a consultant that serves as an investment fiduciary. Consider having an ERISA 3(38) investment advisor manage your fund roster and investment lineup.

Setting Up a 401(k)

There are multiple steps involved in setting up a 401(k) for your business, and you should consult with a financial professional before diving in. While the specific steps may differ depending on your plan needs, there are a few general first steps.

  • Choose who will set up the plan. If you don’t want to set up the plan yourself, consult with an advisor, bank, mutual fund provider, or insurance company for assistance.
  • Adopt a written plan. Every 401(k) plan requires a written document, approved by the IRS, that will serve as your go-to guide for plan operations. If you work with an advisor or financial institution, they may provide this for you. Regardless of who creates it, you must adhere to all terms of the document.
  • Set up a trust to hold the plan’s assets. Your 401(k) trust must have one or more trustees who will manage the plan’s investments, contributions, and distributions.
  • Choose a system for recordkeeping. It’s essential to track and attribute all of the plan’s earnings, losses, contributions, expenses, investments, and distributions. Choose a recordkeeping system that will help you prepare the requisite annual report that must be filed with the government.
  • Give your employees the plan information. Provide guidelines on who is eligible and how they can participate. You are required by law to provide a summary plan description (SPD) so employees know how the plan operates.

The Department of Labor offers additional guidelines on setting up and managing a 401(k), and can help business owners navigate these first steps.

Feeling overwhelmed or intimidated? You’re not alone. The process of starting a plan can be complicated, but there are countless resources available online and professionals who can help. Don’t be afraid to consult with several different consultants or firms to find one with which you feel most comfortable.

If you found this information helpful or if you know other business owners considering offering a 401(k), share this article on Twitter and pass it along to a friend in need.

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