As a startup, you want to provide the best benefits for your employees, including retirement plans such as a 401(k), an employer-sponsored plan that allows workers to save and invest for their future.
It is a type of "defined contribution" plan, meaning the employee contributes a set amount of money each year—typically through payroll deductions—into their account, which is then invested in stocks, bonds, and other securities.
Depending on the type of 401(k) you establish, your employees can set aside up to the Internal Revenue Service (IRS) 2023 contribution limit of $22,500 per year, with an additional $7,500 in catch-up contributions for employees aged 50 and older.
Companies often make matching contributions to the accounts as well, increasing the total amount employees save. For most 401(k) types, the account grows tax-free, and distributions are taxed as ordinary income when withdrawn.
A 401(k) plan is a great way to help employees save for retirement. It also provides tax advantages and other benefits for your business.
For example, when you start a 401(k) plan for your employees, you may qualify for tax credits of up to $5,000 per year to cover setup and other administrative costs for the first three years. Matching contributions can also be deducted from your annual tax liabilities.
Additionally, offering retirement benefits like sustainable 401(k) plans as part of your compensation package may help your business attract and retain top talent, increasing your company's competitive advantage.
To maximize the benefits of your 401(k) plan offering and ensure its success, consider the type and design of the 401(k) plan you want to offer, the service provider, and how to establish and maintain the plan for the long term.
There are different types of 401(k) plans for startup businesses to choose from.
Employees can contribute pre-tax dollars from their paychecks to a traditional 401(k) plan, while distributions are taxed as ordinary income at the time of withdrawal. Traditional 401(k) plans help reduce an employee's annual taxable income during the contribution stage.
Withdrawals before age 59 ½ are subject to a 10% penalty with some exceptions due to hardship expenses like funerals, qualified medical costs, and home repairs. Traditional 401(k) follows the IRS 2023 contribution limit of $22,500, which is updated yearly.
Employees 50 years or older can add a catch-up contribution of $7,500 for a total contribution limit of $30,000. You may also offer matching contributions of up to an employer-employee total of $66,000 in 2023 or 100% of an employee's salary, whichever is lesser.
All public or private companies can offer a traditional 401(k), but they must make yearly reports of employee plan information through Form 5500 or the Annual Returns of Employee Benefit Plan.
Unlike traditional 401(k), a Roth 401(k) plan allows employees to save after-tax dollars in their accounts, meaning contributions are not subtracted from taxable income for the year.
Instead, the main benefit is that qualified withdrawals are generally tax-free upon retirement once certain conditions are met, such as completing the 5-year holding period.
Roth 401(k)s follow the same annually updated employee, catch-up, and matching contribution limits set by the IRS. As with traditional 401(k) plans, you also must file employee plan information yearly for this type of retirement account.
The Safe Harbor plan is similar to the traditional 401(k) but offers more protection for small business owners. Employee contributions are funded with pre-tax dollars and grow tax-deferred until withdrawn at retirement when they are taxed at the employee’s ordinary income tax rate.
Companies that offer traditional 401(k) plans are required by the government to conduct nondiscrimination tests to ensure that highly compensated employees (HCEs) are not heavily favored in terms of 401(k) contributions compared to the average worker.
The Safe Harbor 401(k) plan exempts you from undergoing such compliance tests. Instead, you must make either a 3% non-elective contribution or a matching contribution of up to 4%, allowing all employees to benefit from retirement plans, not just HCEs.
It ensures that you can provide retirement benefits to your employees while avoiding the potential refunds and fees involved if you fail the IRS nondiscrimination tests.
This type of plan requires a notice to employees each year informing them of their rights under the plan, along with employer contributions and vesting rules. Aside from this, it follows the same eligibility criteria, reporting rules, and contribution limits as traditional 401(k) plans.
A SIMPLE 401(k) is a retirement savings plan tailored to small businesses, including startups. It stands for Savings Incentive Match Plan for Employees (SIMPLE) and is available for companies with 100 or fewer employees. It also does not require nondiscrimination tests.
It allows eligible employees to contribute pre-tax money from their paychecks to the SIMPLE 401(k) plan, with distributions taxed as ordinary income. You must make either a 3% matching contribution or a 2% non-elective contribution based on an employee's salary.
Like other plans, the SIMPLE 401(k) plan requires annual filing with the IRS through Form 5500 but has lower administrative costs than traditional 401(k) plans, making it more attractive to smaller companies.
However, you must make contributions every year regardless of whether or not the business is profitable. You also cannot offer other retirement plans to your employees.
Lastly, the IRS sets lower contribution limits for SIMPLE 401(k) plans, which may be inadequate for some workers. Employees are limited to $15,500 in annual contribution limits in 2023, with catch-up contributions maxed out at $3,500 for a total of $19,000.
A Solo 401(k), also known as an Individual 401(k), offers the same tax benefits and investment options as traditional 401(k) plans but is tailored specifically for small business owners or self-employed individuals with no employees aside from their spouse.
You are both the employer and employee in a Solo 401(k). As an employee, you can make pre-tax contributions up to the annual limit of $22,500 in 2023. You may also add a catch-up contribution of $7,500 if you are 50 or older.
Furthermore, as the employer, you can contribute up to 25% of net earnings up to a maximum total contribution of $66,000. Your withdrawals upon retirement will be taxed as ordinary income.
A Solo 401(k) plan requires you to file an annual Form 5500-EZ or the Annual Return of One-Participant Retirement Plan if your balance surpasses $250,000. You also need an Employer Identification Number (EIN) to set up the plan.
After choosing which type of 401(k) plan you will offer, you must tailor the specific design or components. Consider your startup's financial standing and business goals to ensure the design fits your situation.
Roth 401(k) deferrals are one option you can include in your 401(k) plan. Employees can choose to save after-tax dollars, meaning they pay taxes on contributions and get tax-free distributions during retirement.
While additional taxes will be due for early withdrawals on earnings, all qualified distributions by age 59 ½ will be completely tax-free, provided that the 5-year holding period has also been completed.
Roth 401(k) deferrals are an attractive option for an employee who prefers more liquidity since contributions made into these accounts can be withdrawn tax-free anytime. It is also beneficial for individuals who believe they may be in a higher tax bracket when they reach retirement age.
You can match a portion of or all employee deferrals up to certain limits established by the IRS. This type of contribution adds value for employees who save for retirement through their 401(k) plans and helps encourage employee participation.
It is important to note that for most types of 401(k), your matching contributions count toward an employee's elective deferral limit, $66,000 for 2023, updated annually.
You must decide if you want to match a percentage of salary deferrals or contributions made on a dollar-for-dollar basis. Remember that matching contributions can provide a substantial tax benefit to your startup.
It can supplement the employer match to maximize the contribution of funds into employees’ 401(k) accounts. Profit sharing is based on a percentage of an employee’s income, not necessarily the amount deferred from their paycheck.
These payments are made directly from you to the plan and count toward an employee’s deferral limit for the year. You can make it discretionary and decide each year if you will award it, or you may have it fixed, meaning you guarantee profit-sharing yearly.
Profit-sharing contributions can be an effective way to reward employees and provide additional retirement savings for them. It also reduces your taxable income and can be used as a tax-deductible business expense.
Vesting refers to the timeframe in which an employee becomes fully entitled to employer contributions made into their account. If employees leave before becoming fully vested, they may be unable to keep all your matching or profit-sharing contributions.
You can choose between two methods: cliff and graded vesting. Cliff vesting requires employees to wait for specific years before becoming eligible for the total employer contribution. If they leave before the vesting schedule, your contributions on their behalf are forfeited.
On the other hand, graded vesting allows participants to receive partial ownership of employer contributions each year until they become wholly vested after the specified timeframe, depending on your chosen schedule.
Typical vesting schedules range from 3 to 6 years. Note that vesting schedules only apply to the matching or profit-sharing contributions. Salary deferrals and contributions are immediately vested since these are paid with an employee's own money.
Now that you have determined the type and design of the 401(k) plan you want to offer your employees, selecting the right provider that meets those needs is paramount.
Make sure to research and review different providers. Consider their fee schedule based on setup, plan management, and investments. The provider must be upfront with all possible costs. You want to avoid hidden or surprise charges.
Look for a service provider that assists you in setting up the 401(k) plan. They should also have customer support and answer any questions you or your employees may have on the plan. A good provider helps decrease your human resource department's workload.
Consider the provider's technology or system in administering the 401(k) plan. For example, examine their payroll integration capabilities.
You should also consider additional services they can provide, such as compliance testing, annual notices, IRS reporting, and employee education materials. A lot of 401(k) service providers are available, so do your due diligence for a successful plan offering.
Once you have chosen a plan design and provider for your 401(k) plan, it is time to set it up. It involves drafting a formal document to describe the plan, creating a trust, hiring a record keeper, and preparing employee notifications.
Your 401(k) plan provider can help guide you through this process.
The first step in establishing your 401(k) plan is to draft a formal, written document that describes the plan and its details. This document must include specific information about vesting schedules, eligibility requirements, contribution limits, and withdrawal rules.
When drafting this document, working with an attorney or other professional specializing in employee benefits law is essential to ensure all legal requirements are met.
Additionally, it would be best to involve any key employees or stakeholders in creating this document, as they will be affected by the terms stated within it.
Next, you must create an irrevocable trust for the plan. This legal entity holds qualified retirement plan assets on behalf of participants.
The trust will protect from creditors and legal judgments and ensure that all contributions are used exclusively for the benefit of plan participants.
This individual or company will be in charge of the day-to-day administration of your 401(k) plan. They are responsible for keeping track of participant accounts, handling all paperwork associated with the plan, and ensuring compliance with applicable regulations.
Their task also includes issuing reports to the IRS and providing customer service to employees. It is important to carefully research potential record-keepers or third-party administrators and ensure their fees align with market rates for similar services.
Finally, you must create and distribute communications to all eligible employees. It should include details about how the plan works, contribution limits, eligibility details, vesting schedules, withdrawal rules, and legal rights and responsibilities.
You can do this in various ways, such as through formal handbooks or employee meetings.
Providing education and investment advice is also beneficial to ensure employees make informed decisions about their retirement savings.
You must also ensure that all employees receive notifications regarding their participation in the plan. These notices typically include an annual statement specifying how much each employee has contributed and what type of investments are in their account.
Establishing a 401(k) plan is just half the battle. You need to understand the ongoing responsibilities of 401(k) plan administration to create a successful retirement savings program for your startup.
As referenced in earlier sections, you are required to file Form 5500 with the IRS and the Department of Labor (DOL) every year for your 401(k) plan, as mandated by the Employment Retirement Income Security Act of 1974 (ERISA).
This form provides information about the status of the plan, its assets and investments, participant contributions and withdrawals, operations, any plan changes, and other compliance requirements.
Under ERISA, you must maintain a fidelity bond for your 401(k) plan. This type of bond protects the assets in your 401(k) plan from loss due to fraud or dishonesty by any fiduciary or service provider.
The Department of Labor requires you to purchase enough coverage to protect at least 10% of the total funds in the 401(k) plan. The minimum amount depends on how much the plan holds each year.
Depending on the specific type of 401(k) plan you choose, you may need to comply with IRS nondiscrimination tests each year. It will ensure that the 401(k) plan benefits are fair and not disproportionately advantageous to higher earners or owners.
These tests measure a few factors, including average deferral percentage (ADP) and average contribution percentage (ACP). If your plan fails any of these tests, you must make adjustments and potentially restructure your plan.
Traditional and Roth 401(k) plans require nondiscrimination tests, while Safe Harbor, SIMPLE, and Solo 401(k)s are exempted.
Part of keeping your 401(k) plan compliant is staying on top of IRS and DOL deadlines. It includes filing Form 5500 annually and any other government-required reports.
For example, in the case of Form 5500, you must submit it by July 31 to cover the previous 401(k) plan year. It must be filed electronically through the ERISA Filing Acceptance System II (EFAST2).
Providing 401(k) plans for your employees can help your startup business succeed. Not only does it help your employees save for their retirement and give you tax advantages, but it also helps attract and retain top talent, making you competitive.
Depending on your startup's financial situation and goals, you can choose between traditional, Roth, SIMPLE, Safe Harbor, or Solo 401(k) plans. You can tailor the plan design based on Roth deferrals, matching and profit-sharing contributions, and vesting schedules.
Consider costs, technology, customer and compliance support, and other services when choosing a 401(k) plan provider. They can help you establish and maintain your 401(k) plan to ensure long-term success.
First, you must choose between traditional, Roth, SIMPLE, Safe Harbor, or Solo 401(k) plans. Then you can design the plan specifics while selecting a competent service provider to help establish and maintain the 401(k) plan.
Consider costs, transparency, technology and system used, customer assistance, compliance support, and other additional services. You should do your due diligence to ensure that the service provider fits your startup's needs and goals.
When it comes to 401(k) contributions, companies typically match a percentage of their employee's contributions up to a certain limit. They may also offer profit-sharing contributions depending on employee salary. Remember that the Internal Revenue Service (IRS) sets annual limits for total contributions. For 2023, the total limit is $66,000.
Mutual funds are the most common 401(k) plan investment option. Specifically, many employers will offer a variety of target-date funds as the default investment choice. This type of mutual fund is inherently diversified and manages overall risk by gradually shifting the asset allocation to become more conservative as investors approach retirement.
Yes. It is common for startups to offer a matching contribution with their 401(k) plans. You must decide whether to provide a match on employee contributions and what percentage of the match to offer. Employer matches are typically discretionary and can be adjusted or suspended at anytime. You can benefit from tax deductions because of matching contributions. It can also increase employee morale, leading to loyalty and better performance.