When job hunting, many employees expect a 401(k) as part of their benefit plan. Providing the option to save for their retirement can help attract and retain employees. This article will explain the basics of a 401(k), spelling out how they work and why they are beneficial for small business owners. Then, we'll go into the steps you'll need to take to start offering 401(k) plans to your employees.
What Is a 401(k)?
Before the popularity of 401(k) plans, many private-sector employees relied on traditional pension plans. Fewer of today's businesses are offering pension plans, giving rise to 401(k) plans. A 401(k) plan allows individuals to claim tax deductions when they place money into their retirement account. When someone has a 401(k) account, they can contribute some of their earnings into their account.
Employee 401(k) accounts are one of the best investment options they have for saving for retirement. If they take money from their Social Security at full retirement age, it will only account for about 40% of their income. However, financial planners recommend replacing between 70% and 90% of expenses. Combining Social Security benefits and a 401(k) plan can help employees create a better retirement fund so that they can maintain the same standard of living and lifestyle they're accustomed to.
Aside from retirement planning, investing in retirement can make employees eligible for certain tax credits. A traditional IRA (individual retirement account) or Roth IRA and salary deferral contributions to a 401(k) can all provide a tax credit. Depending on the employee's adjusted gross income, they can receive a tax credit of 10%, 20%, or 50%.
Why Offer a 401(k) at Your Small Business?
Depending on the state in which you conduct business, you may not be required to offer a 401(k) plan to your employees. With that said, there are a number of states that require nonprofit and private-sector businesses to offer employees a retirement savings plan, such as a state-sponsored Roth IRA plan. Even if your state doesn't require you to offer a retirement saving plan, employees may expect it.
Of the most common employee benefits offered, retirement savings plans are the second-most offered benefit. Just behind health insurance, it's clear how important retirement savings plans are to the American workforce. Moreover, 87% of the retirement plans offered are 401(k) accounts.
A 401(k) plan is an employer-sponsored account, meaning employers can make matching contributions to eligible employee accounts. Typically, matching is a portion of the employee contribution. For example, let's say you offer to match 100% of employee contributions up to 5% of their wages. If an employee earns $2,000 a paycheck, you would match up to $100.
The reality is that most small business employees want the option to have a 401(k) account. One study found that 88% of employees expect a business to offer a 401(k) as a benefit.
How to Start a 401(k) at a Small Business
Offering 401(k) benefits to your employees is much more affordable than you may think. Today's technology empowers small business owners to offer 401(k) plans that make it easy to invest. In this next section, we'll break down the steps you'll need to take to start a 401(k) at your business.
Decide Which Type of 401(k) to Offer
There are several 401(k) plan types that a small business can offer. Each option has its tax benefits and drawbacks. In the next sections, we'll cover the traditional 401(k) and Roth 401(k), the Small Business 401(k), and the Safe Harbor plan.
Traditional vs. Roth 401(k)
With a traditional 401(k) plan, the employee can invest a portion of their income before taxes. Although the tax is not taken out when they invest it, they will need to pay taxes once the money is withdrawn for retirement.
Another option is a Roth 401(k), which uses already taxed income to invest. When someone pulls from a Roth 401(k) account in retirement, they won't have to pay taxes when withdrawing their money because they already paid taxes on it.
The difference between the two whittles down to when the taxes will be paid on the income. Traditional 401(k)s have a tax break upfront, which benefits the employee by lowering their income tax bill. On the other hand, employees don't have to worry about being taxed when pulling from a Roth 401(k) during retirement.
Small Business 401(k)
No matter how big or how small your business is, you can start a 401(k). The Small Business 401(k) was designed with self-employed individuals in mind. Often referred to as a solo 401(k), small business owners can make contributions to their account with pre-tax dollars. Salary deferrals, which occur when money from your paycheck goes directly to a retirement savings plan can help grow your savings tax-free until they are withdrawn at retirement. If you choose this plan, be mindful that the Internal Revenue Service (IRS) has contribution limits for the amount a self-employed person can contribute to the plan.
Safe Harbor 401(k)
This tax-deductible 401(k) plan makes sure that all employees have a set of minimum contributions made to their 401(k) accounts. For Safe Harbor 401(k)plans, employers provide fully vested contributions on behalf of their employees each year. This type of plan is beneficial to employers because it helps support employees who are saving for retirement and it reduces much of the administrative work for small business owners.
SIMPLE 401(k)
This 401(k) plan was developed for small businesses wanting a low-cost way to offer employees retirement benefits. Under this style of 401(k) plan, which is only available to companies with fewer than 100 employees, small business owners' contributions must be fully vested.
Find a 401(k) Provider
As you can see, there is a variety of 401(k) plans to choose from. The same can be said for 401(k) providers.
When choosing the right provider, it's important to consider the size of your business. While larger companies might have the additional resources to handle a less-involved provider, many small businesses can't. Not every provider will be able to meet your needs, which is why it's important to search for a 401(k) provider that works specifically with small businesses.
Popular 401(k) providers for small businesses include:
Appoint a 401(k) Trustee/Recordkeeper
All 401(k) plans get funding from a trust. This trust is established to hold and invest the assets in the plan. The trust requires an appointed trustee to handle investment management. In most cases, the business owner, a trusted employee, or a financial institution will manage the fund's assets.
It's incredibly important that the trustee is selected with careful consideration. They are trusted with managing all of the 401(k) assets, which is an important responsibility. Plus, trustees can face legal repercussions for mismanaging money. If there has been any negligence, the trustee can't plead ignorance. For this reason, it's vital that the trustee is fully qualified to handle the responsibilities.
Adjust Your Small Business Accounting for the 401(k)
As the small business owner, you would be the sponsor of the plan. The plan sponsor is fully responsible for making sure that the plan is in compliance with all rules and regulations related to it. The plan sponsor is also responsible for additional filing requirements, which include reporting wages and elective deferrals for the plan.
To ensure that all documents are in order, it's a good idea to have quick access to your financial documents. Skynova's accounting software was created for small businesses wanting to have easy access to their records. Plus, using a comprehensive solution like this one simplifies the accounting process. This way, adding a 401(k) plan won't add too much stress to your business, and you can focus on what truly matters.
Establish and Implement Your 401(k) Policy
The next step in starting a 401(k) is setting up policies. Often, businesses require employees to have worked for the company for a specified period before they are eligible to make contributions to the account. While some companies have a three-month period before employees can make contributions, some require employees to work there for an entire year before they are eligible.
Additionally, some 401(k) plans require eligible employees to be at least 21 years of age to contribute. Regardless of the restrictions you choose for eligibility, it's important to write out the requirements and share the guidelines with employees. Once you've established eligibility requirements, sharing important plan information with employees should continue.
For example, the plan administrator is required to provide plan participants with a Summary Plan Description (SPD) and Summary Annual Report each year. Visit the IRS website to learn more about plan sponsors for small businesses and specific guidelines for starting your small business retirement plan.
Ensure Accurate Record-Keeping With Skynova
An important part of any small business is record-keeping. This is especially important for small business retirement plans because of the additional records the IRS may request. Luckily, there is a way to compile all of the important accounting and financial information for your business in one solution: Skynova's accounting software. See how our software products can help streamline your business today.
Notice to the Reader
The content within this article is meant to be used as general guidelines and may not apply to your specific situation. Always consult with a professional financial advisor to ensure you're meeting accounting standards and choosing the right 401(k) plan.