How to Set up a 401(k) For Small Business

Overview of 401(k)

A 401(k) is an employer-sponsored retirement savings plan that allows employees to defer a portion of their salary and save it into an account. The money is invested into various securities such as stocks, bonds, or mutual funds.

In a 401(k) plan, employees make regular contributions up to the limits set annually by the Internal Revenue Service (IRS), usually on a pre-tax basis. It means that the employee does not pay taxes on the amount they contribute to the plan until they withdraw it in retirement.

For 2023, employees can put aside a maximum of $22,500 into their 401(k) accounts, with an additional $7,500 catch-up for those aged 50 years or older.

The employer may also choose to match part or all of the contributions up to a combined employer-employee contribution of $66,000 ($73,500 for aged 50 or older employees), further increasing the employee’s savings potential.

This matching contribution is generally invested into the same investment options the employee selects. Typically, employees can decide how and where their 401(k) funds are invested, depending on their financial goals, risk tolerance, and the plan options offered.

Benefits of Setting up a 401(k)

A 401(k) plan allows employees to prepare for their financial future. As an employer, you also benefit from sponsoring a 401(k) plan in the following ways:

Attracts and Retains Top Talent

Setting up and offering a 401(k) plan as part of your employee benefits package increases your company's competitiveness. Potential employees typically look for retirement plans when accepting a job offer.

It can also help your company retain your current employees. Offering a 401(k) plan can increase employee satisfaction and loyalty to your business.

Enhances Work Ethic

Increased job satisfaction and loyalty lead to an enhanced work ethic. Employees with a stable financial future through retirement savings feel more secure and content. This improved attitude can lead to better morale, higher productivity, and better workplace culture overall.

Increased employee productivity boosts your company's business performance.

Reduces Tax Liability

As a business owner, you may also contribute to your own 401(k) account and defer as much as the IRS contribution limits set for employees. If you choose a traditional 401(k), your contributions are made before taxes.

Your own 401(k) contributions can potentially put you in a lower tax bracket, thereby decreasing your overall personal tax liabilities.

Provides Tax Credits

Small businesses may qualify for tax credits to cover costs associated with setting up a 401(k) plan for their employees. There are also tax credits available for employers which implement an automatic enrollment plan feature.

These credits can help you offset the costs of starting a 401(k) plan for your small business by lowering dollar-for-dollar the amount of tax you need to pay. If you need help setting up a sustainable 401(k), we can help you find answers to your tax credit questions. 

Allows Tax Deductions

Lastly, if your company elects to offer matching contributions to your employees' 401(k) accounts, you may qualify for tax deductions. Employer matching contributions can be considered part of ordinary business expenses, capped annually to 25% of covered payroll.

Profit-sharing contributions may also be part of a 401(k) plan and entitle your business to additional tax deductions.

How to Set up a 401(k) Plan for a Small Business

Consider the following steps in setting up a 401(k) plan for your small business:

Step 1: Choose the Type of 401(k) Plan

There are several 401(k) types for employers to choose from. Traditional 401(k)s involve pre-tax contributions, where employees pay taxes when they withdraw their money during retirement. Roth 401(k)s allow participants to contribute after-tax dollars for tax-free withdrawals later.

You may also opt for a Safe Harbor 401(k), which involves employer-matching contributions and allow businesses to skip certain nondiscrimination tests.

SIMPLE (Savings Incentive Match Plan for Employees) 401(k)s, on the other hand, require employers to make either matching or non-elective contributions. Consider the details of each plan type before deciding which best fits your business needs.

Step 2: Find a Provider for the 401(k) Plan

Once you have chosen a plan type, you must decide if you want to manage it within the company or hire a third-party service provider. Managing your plan internally can save you on costs but may be time-consuming, error-prone, and may divert you from your business.

Hiring a professional institution can help you avoid costly mistakes, lessens your workload, and lets you focus on running your business. Should you decide to outsource, consider providers with specialized services and competitive fees.

Check if the provider offers extras such as recordkeeping, administrative support, participant education material, customer service, and more. Also, ensure the provider has the licensing and insurance qualifications needed for your chosen 401(k) plan type.

Step 3: Create a Written Plan Document

The written plan document outlines the details of your 401(k) plan and is legally binding. It contains the set of rules that govern your small business 401(k). It includes the plan type, employee eligibility, payroll deferral process, and distribution rules.

Ensure it contains all other relevant information like matching or profit-sharing contributions, vesting schedules, contribution limits, and borrowing rights. It should also include the terms of how you will manage the plan and other related matters.

The written plan must be clearly understood by all stakeholders before signing off on the document.

Step 4: Arrange a Trust

The trust account is where the 401(k) plan’s assets are held. The trustee may be an individual appointed by you or an institutional custodian.

They are responsible for managing and investing the funds on behalf of participants. Whichever individual or firm you decide to go with, ensure they are insured and have the necessary qualifications to manage your plan.

Establishing a trust ensures that only participants and their beneficiaries can use the 401(k) funds. It adds a layer of security and makes it easier to manage plan assets.

Step 5: Establish a Recordkeeping System

A recordkeeping system is essential to any 401(k) plan. Your small business must maintain records of all plan activities and transactions, employee contributions, employer matching or profit-sharing contributions, plan expenses, earnings and losses, and withdrawals.

Choose a recordkeeper who can handle the day-to-day administrative duties of your 401(k) plan, such as maintaining balances, allocating contributions, and processing distributions. They will also be responsible for filing the required tax and other compliance forms on your behalf.

Many financial institutions offer recordkeeping services, so be sure to compare fees and services before making a decision.

Step 6: Communicate the 401(k) Plan to Employees

Once you have set up your 401(k) plan, it is important to communicate the details of the plan to your employees. It is a necessary step so that your employees can avail of the retirement savings benefits of your 401(k) plan.

It includes educating them on how they can enroll in the plan, contribution amounts, vesting schedules, and other relevant information. Providing a comprehensive overview ensures that your employees understand the plan and can make informed decisions about their retirement savings.

Additionally, you must provide timely updates regarding any changes in the 401(k) plan. This will keep your employees up-to-date on their benefits and help them maximize their retirement savings opportunities.

Cost of Setting up a 401(k) Plan For Small Business

Generally, sponsoring a 401(k) plan includes one-time setup fees and annual administrative charges. The cost of setting up a 401(k) plan for your small business depends on the type of plan you choose, the specifics of the plan document, and the services or products included.

It will also depend on the third-party provider and the services you require from them. Setup fees can range from $500 to $3,000, depending on the number of employees and the provider you choose.

In addition to setup fees, you will pay administrative costs for the day-to-day management of your small business 401(k). You may also incur other expenses, such as annual audit fees, filing fees for IRS forms, legal services, and investment management fees.

Take all these factors into account before committing to a 401(k) plan provider. It will ensure that your employees can access the best retirement savings opportunities available.

The Bottom Line

A 401(k) is a type of retirement savings plan offered by some small businesses to their employees. It allows participants to contribute a portion of their salary, which is put into investment funds that can grow over time.

Employers often match employee contributions up to a certain amount, essentially providing an additional funding source for retirement.

Setting up a 401(k) plan for your small business is a great way to incentivize employees, increase job satisfaction and morale, and let them start planning for their financial future. It may also qualify you for tax deductions and credits.

The essential steps in setting up this retirement savings plan revolve around specifying the type of 401(k) plan you want to offer, selecting a service provider, designing a written plan document, arranging a trust, establishing a recordkeeping system, and informing employees.

Costs include one-time setup ranging from $500 to $3,000 or more depending on the complexity of the plan, the size of the business, and the provider and its services. You will also pay ongoing administrative and other fees.

Consult a qualified financial advisor or retirement plan provider to ensure you create the best 401(k) plan for your small business.

How to Set up a 401(k) For Small Business: Step-by-Step Guide FAQs

What is a 401(k) plan?

A 401(k) plan is a type of retirement savings plan that allows employees to contribute salary deferrals, which are invested and grow until the employee retires. Employers may also choose to offer matching contributions as an incentive for employees to save. Contributions can be made with pre-tax or after-tax dollars, which offer different tax advantages later.

Who is eligible to participate in a 401(k) plan?

Most individuals who work for a small business offering a 401(k) plan may participate in one. Specific eligibility requirements may vary from company to company, depending on the terms of the plan document. Generally, eligibility is based on employee age and length of stay with a company.

How much can an employee contribute to a 401(k) plan?

The maximum 401(k) contribution amount allowed by law for 2023 is $22,500 for employees under the age of 50 and $30,000 for those 50 or older. Additionally, employers may opt to match employee contributions up to a certain percentage. This amount can vary from company to company depending on their budget and individual policies. The combined employer-employee contribution is capped at $66,000 in 2023 ($73,500 for employees 50 or older).

How much does it cost to set up and administer a 401(k) plan?

The cost depends on the number of employees, the third-party provider, and the specific services you require. Generally, set-up costs range from $500 to $3,000 or more. Ongoing administrative and other fees vary.

Can a small business owner also participate in a 401(k) plan?

Yes, a small business owner is eligible to participate in their own 401(k) plan. They can contribute amounts subject to annual Internal Revenue Service (IRS) limits. Employers who choose to make matching contributions or other employer-funded contributions may be able to deduct those amounts from their taxes.