How to Set up a 401k Plan for Small-Business Employees
- Employee Benefits
6 min. Read
Last Updated: 12/08/2023
Table of Contents
The right 401(k) plan for your small business gives you an advantage in competitive job markets and helps your employees. As top candidates weigh the pros and cons of different employment opportunities, offering a 401(k) plan is among the best ways to help your business attract and retain quality talent. Additionally, tax benefits and owner retirement savings options make setting up a 401(k) plan a smart benefit.
Learn more about the advantages of establishing a retirement program at your business, and how you can make setting up a 401(k) plan for your employees straightforward, manageable, and affordable.
What are the benefits of offering a 401(k) to employees?
When it comes to 401(k) plans, there are often common misconceptions around the time, resources, and costs it takes to establish and set up a plan. 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. In truth, there are some significant advantages in offering a 401(k) plan to employees:
- A 401(k) can help make your business more competitive in attracting and retaining top talent.
- Your business might be eligible to take advantage of retirement plan tax credits of up to $5,000 a year over three years and an auto-enrollment credit of $500 a year over three years, for a total tax credit of up to $16,500, if you start a new plan.
- Under SECURE Act 2.0, the employer contribution credit is available for eligible businesses. The credit is generally a percentage of the amount contributed by the employer, up to $1,000 per employee. It is limited to employers with 50 or fewer employees and reduced for employers with between 51 and 100 employees.
- Plan expenses are tax-deductible, along with employer contributions such as an employee match or profit sharing.
- Advances in payroll integration and administration make the setup 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 benefits of a 401(k) retirement plan include a broad range of advantages for both employers and employees. Along with a vesting schedule to incentivize retention, both business owners and staff can benefit from:
Tax-advantaged retirement saving: With a 401(k), employees can save upfront with pre-tax dollars while they are working. By the time they need their savings to fund their retirement, they will likely be in a lower tax bracket, which can generate long-term tax savings.
Employer match: Contributions are among the top benefits of 401(k) plans for employees. Under SECURE Act 2.0, up to $1,000 per employee in credit is available for eligible businesses. The employer contribution credit is generally a percentage of the amount contributed by the employer. It is limited to employers with 50 or fewer employees and reduced for employers with between 51 and 100 employees.
Defrayed 401(k) plan startup costs: Eligible employers may be able to claim a tax credit of up to $16,500 over the first three years to pay for associated costs of starting a qualified plan such as a 401(k) for employees.
How to set up a 401(k) plan for your employees
The process of how to set up a 401k plan for your small business is similar to making other important decisions. You'll need to do your research, make decisions based on your findings, 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, reputable 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.
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 option. 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 employees 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.
How to set up a 401k for a small business
Setting up a 401(k) for your small business includes some crucial steps, some of which may be handled by your chosen provider. It's important to remember that the employer maintains a 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. Another fiduciary, such as the employer who sponsors the qualified retirement plan, will generally assign the trustee.
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 such as Paychex to help them manage plan setup and ongoing record management.
4. Provide information to plan participants
You're required to provide certain information to plan participants about plan benefits, rights, and features. You must also provide a summary plan description (SPD) to inform participants and beneficiaries about the plan and how it operates. On an ongoing basis, you must also provide information to keep plan participants updated on investments and changes (financial institutions may provide this as well, and can serve as a resource for employees). 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.
Common questions plan participants may ask employers about a new 401(k) plan:
- Do I need to enroll in a 401(k) plan?
- Does my employer match my contributions?
- How can I set up a 401(k) plan?
- Is there a minimum amount I need to contribute to my 401(k) plan?
- Is there a maximum amount I can contribute to my retirement plan?
How much should an employer contribute to the plan?
The amount you as an employer decide to contribute is entirely up to you. As you make this decision, consider the tax savings you can receive for making employer contributions. Employer matches are tax-deductible on federal corporate income tax returns, and some administrative fees associated with managing a 401(k) plan are tax-deductible as well.
You can match 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 $69,000 for 2024, not including "catch-up" elective deferrals of $7,500 for employees age 50 or older.
Also consider factors such as the positive impact a matching contribution can have on employee morale and worker retention strategies. Given the steep costs of hiring and training new employees, an employer match offers the opportunity to truly invest in your workforce. These considerations may help guide your decisions about how much to contribute to the 401(k) plan.
How much should employees contribute?
Like the employer, employees are free to contribute as much as they like to the plan, within IRS limitations. For 2024, salary deferrals are $23,000, plus a catch-up contribution limit of $7,500 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 to set up a 401(k) plan 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, depending on the chosen retirement service provider. 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 you establish a 401(k), your business will have ongoing costs in the form of administrative fees and any matching contributions. Fees generally fall into three categories: day-to-day operations, investment fees, and individual service fees.
There are also potentially fees or penalties associated with being non-compliant with regular 401(k) reporting, which you'll want to avoid at all costs. An example includes non-compliance with filing and notification requirements pertaining to ERISA.
One way to avoid fines and penalties is working alongside a knowledgeable retirement services provider that can help ensure compliance when it comes to retirement plan forms, deadlines, and notifications.
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. Businesses should do preliminary research, allowing ample time to create a plan document, establish a trust, notify employees, and launch the new benefit.
Managing 401(k) plans for a small business
Look for a provider with an excellent track record that can help you get your 401(k) 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.
**Largest 401(k) recordkeeper by number of plans, PLANSPONSOR magazine, 2023