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

Employee Benefits
Article
12/13/2019

As top candidates weigh the pros and cons of different employment opportunities in a competitive job market, offering a 401(k) plan is among the best ways to help your business attract and retain quality talent. Additionally, other advantages such as tax benefits and owner retirement savings options make setting up a 401(k) plan a smart benefit option.

However, business owners may believe that a 401(k) plan isn't right for them, are unclear of the benefits, or believe the administrative responsibilities are too cumbersome.

What are the benefits of offering a 401(k) to employees?

To overcome misconceptions and understand the potential impact a plan can have on a business, it's important to know the benefits of a 401(k) retirement plan:

  • A 401(k) can help make your business more competitive in attracting and retaining top talent.
  • Employers can take advantage of an annual tax credit of up to $500 for the first three years of the plan.
  • Plan expenses are tax-deductible, along with employer contributions such as an employee match or profit-sharing.
  • Advances in payroll integration and recordkeeping make the implementation and maintenance of offering a retirement plan more affordable than ever.

What are the benefits of a 401(k) plan compared to other retirement options?

When compared to other retirement options (SIMPLE IRA, SEP IRA, and profit sharing), the 401(k) offers the broadest range of benefits for both employer and employee. Both enjoy upfront tax savings, and the 401(k) can include a vesting schedule to incentivize retention.

Setting up a 401(k) plan for your employees

The process for setting up a 401(k) plan for your small business is similar to making other important decisions. You'll need to do your research, make decisions based on your research, and then take appropriate action.

Research retirement options for your business

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 assemble your list, include a range of established, well-reputed mutual fund companies, brokerage firms, and insurance companies. Focus on 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.

"We did shop around to understand what different companies had to offer a small business like Slate. We focused on traditional providers of 401(k) retirement programs and contacted the big national investment firms," Podevels says. Slate Medical also included its payroll provider, which offers retirement plans, in its consideration.

Choose 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 plan. Employers can make contributions for all participants, match employees' deferrals, do both, or neither.

2. The safe harbor 401(k) plan, which has several variations and requires the company to make a mandatory contribution to the plan participants. The contributions benefit the company, the business owner, and highly compensated employees (HCEs) by giving them greater ability to maximize salary deferrals.

3. An automatic enrollment 401(k) plan, which allows you to automatically enroll employees and place deductions from their salaries in certain default investments unless employees elect otherwise. This arrangement encourages 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.

Setting up a 401(k) for a small business

Setting up your plan includes some crucial steps, some of which can be outsourced, but the employer maintains a fiduciary duty to ensure that the plan is providing a benefit to participants. The U.S. Department of Labor (DOL) provides in-depth details of the process:

1. 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.

2. Set up a trust to hold the plan assets

A plan's assets must be held in trust to assure its assets are used solely to benefit the participants and their beneficiaries. At least one trustee must handle the plan's activities regarding contributions, plan investments, and distributions. Given that these decisions affect the plan's financial integrity, selecting a trustee is a critically important decision.

3. Maintain records of 401(k) employee contributions and values

Maintain accurate records that track employee contributions and current plan values. Many small businesses choose to work with a 401(k) recordkeeper to manage plan setup and ongoing record management.

4. Provide information to plan participants

Provide periodic information to plan participants to keep them updated on investments and changes. 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 decide to contribute is entirely up to you. As you make your decisions, consider the tax savings you receive as an employer and the positive impact a matching contribution will have on employee morale. You can donate 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 $57,000 for 2020, not including "catch-up" elective deferrals of $6,500 for employees age 50 or older.

How much should employees contribute?

Like the employer, employees are free to contribute as much as they like, within the IRS limitations. For 2020, salary deferrals are $19,500, plus a catch-up contribution limit of $6,500 for employees 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 it cost to set up a 401(k) for a small business?

Costs will vary depending on the size of your business and the types of benefits you select. Initial setup fees can generally run anywhere from $500 to $3,000. Other costs to consider are fees associated with rolling assets over from another plan and initial consulting costs for investment advice.

What are the maintenance costs for setting up a 401(k)?

Once a 401(k) is established, your business will have ongoing costs in the form of administration and matching employee contributions, which are important to understand. Fees generally fall into three categories: day-to-day operations, investment fees, and individual service fees. In 2019, the DOL announced a new rule allowing small businesses to band together to offer retirement plans to their employees through Association Retirement Plans (ARPs). Finally, avoid any unnecessary fees or penalties that are associated with being non-compliant with regular 401(k) benchmarking.

How long does it take for a small business to set up a 401(k)?

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.

Managing 401(k) plans for a small business

Setting up a 401(k) can be complicated, but you don't have to do it alone. Look for a provider with an excellent track record that can help you get started, manage your plan, and even share 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.

This website contains articles posted for informational and educational value. Paychex is not responsible for information contained within any of these materials. Any opinions expressed within materials are not necessarily the opinion of, or supported by, Paychex. The information in these materials should not be considered legal or accounting advice, and it should not substitute for legal, accounting, and other professional advice where the facts and circumstances warrant.