4 reasons why small businesses should start a 401(k)
Helping employees save for retirement is one of the obvious reasons to start a 401(k) plan. But 401(k) plans can also help your business save money and attract and retain talent. And thanks to new tax incentives and modern technology, 401(k) plans can be easier to administer and more affordable for small businesses to offer.
Thinking of offering retirement benefits for your employees? Here’s why 2025 is the year your small business may want to introduce a 401(k) plan.
1. Tax credits
The cost of starting a new 401(k) plan can add up. In an effort to make them more affordable for small businesses, Congress passed the SECURE Act in 2019 and a set of enhancements in the SECURE 2.0 Act in 2022. One of the enhancements provided in SECURE 2.0 increased an existing tax credit for starting a new 401(k) plan from a maximum of $500, to up to $5,000, per year for up to three years—up to $15,000 in total if eligibility requirements are met! The credit was increased to up to 100% of qualified startup costs required to set up a plan, administer it, and educate employees.
The SECURE Act also added a new $500 credit (per year for three years) for setting up a plan with an Eligible Automatic Contribution Arrangement (EACA) or a Qualified Automatic Contribution Arrangement (QACA) feature—giving employers an additional $1,500 to offset plan costs. The credit would also be available to employers that convert an existing plan to a qualifying automatic enrollment feature (EACA or QACA). This means that the new maximum eligible tax credit for offering a new 401(k) plan is now $5,500 for up to 3 years or $16,500 in total. While auto-enrollment boosts plan participation rates, it can also increase costs if your company has a match or profit sharing program. Employees can voluntarily opt-out or un-enroll from the plan at any time.1
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2. Tax deductions
While employers are not required to match employees’ 401(k) contributions, many choose to do so for their employees benefit and their bottom line. Employer contributions are tax-deductible if made timely and are not subject to Social Security or Medicare taxes. When making an employer match or profit sharing contribution, your company can save money on taxes and reward your employees’ hard work. How much your company chooses to contribute is completely up to you, but here are a few ways to do so:
- Partial match. An employer contributes a percentage of an employee’s elective deferral contributions, up to a certain limit. The most common employer match is 50% of employee contributions up to 6% of an employee’s eligible compensation.
- Full match. With a full match, or "dollar-for-dollar" match, an employer matches 100%of employee contributions up to a certain limit.
Some companies also choose to make a profit sharing contribution to employee retirement accounts. Profit sharing allows employers to assess their finances at the end of each year before deciding if and how much they want to contribute to employee accounts. Like an employer match, there are several options employers have when it comes to making a profit sharing contribution:
- Same dollar amount method. An employer contributes the exact same dollar amount to employees regardless of age, tenure, seniority, compensation, etc. This is typically identified as a "flat dollar" method.
- The comp-to-comp method, also known as the "pro rata method," distributes the profit sharing pool based on an equal percentage of an eligible employee’s compensation.
- New comparability method. This method allows employers to segment employees as individuals or into defined groups and determine the contribution amounts per individual or defined group. While this gives a business the flexibility to distribute funds across its workforce, the plan must also pass the IRS "general test" to prove the plan doesn’t discriminate against non-highly compensated employees with their contribution.
3. Talent acquisition and retention
Guideline data shows that one in two employees would turn down a job offer from a company that did not offer a retirement benefit. In addition, 70% of employers surveyed said sponsoring a retirement plan has positively impacted their ability to recruit and hire talent.2
Aside from helping companies attract talent, 401(k) plans can engage your existing employees by helping to ease the financial and emotional burden that comes with saving for retirement. Just as companies’ 401(k) contributions are tax-deductible, so are employee contributions. Employee 401(k) contributions are deducted directly from employee paychecks with the option to defer taxation on their pay (lowering their taxable income now) by using the pre-tax deferral type or enjoy the benefit of tax-free distributions by using the Roth deferral type and paying taxes on their income now while allowing them to put money towards their future.
Lastly, 401(k) plans can help you retain top performers as well. Most companies that offer matching or profit sharing contributions also implement a vesting schedule for these funds. A vesting schedule not only helps your company minimize losses if an employee leaves your company, but also incentivizes employees to stay at your company longer while accruing vesting of your employer contributions.
4. Easy and affordable
Historically, 401(k) providers catered to large, wealthy corporations. Exorbitant fees and administration headaches made offering 401(k) plans impossible for many small companies.
Modern 401(k) providers, like Guideline, offer 401(k) plans designed specifically for small businesses — covering almost all of the administrative work.3 Coupled with the SECURE Act’s tax incentives, the right 401(k) provider can help your business save money while allowing you and your employees to save for a better retirement.*