/ 401(k) Basics

The Step-by-Step Guide to Offering a Small Business 401(k)

Offering a 401(k) sends a great message to your employees — that you’re invested in their future and want them to have a retirement they can look forward to. Recent research shows that half of American families have no retirement savings, and that less than half of small businesses offer a retirement plan. Given this unfortunate reality, it’s not surprising that going the extra mile by offering a 401(k) can have a big impact on the way your employees think about your company: The research also shows that close to 6 in 10 workers who are extremely satisfied with their benefits are also extremely satisfied with their jobs.

If you’re thinking about offering a small business 401(k) plan or switching to a new provider, you’re in the right place. This comprehensive guide covers all of the basics (and some of the not-so-basics). Here’s what we’ll cover:

  • How do I set up a small business 401(k)?
  • What are the fiduciary responsibilities for a 401(k) plan?
  • How do I choose a small business 401(k) provider?
  • 401(k) tax benefits, Safe Harbor plans, and other details


How do I set up a 401(k)?
For businesses that are ready to take the plunge, the IRS website covers the actions you need to take to get everything set up. In the event you don’t speak in tax code, here’s a more approachable look at what goes into setting up a 401(k) for small business:

Step 1: Choose a plan type
The main difference between 401(k) plans is how and when an employer makes contributions on behalf of its employees. There’s no requirement that employers make contributions at all, but a 401(k) plan can skip nondiscrimination testing altogether if contributions are made in specified ways.

The IRS has designed annual nondiscrimination testing to make sure the plan a business offers is accessible to all its employees. If your plan were to fail one of these tests, it could mean making expensive corrections, a lot of administrative work, and potentially even refunding 401(k) contributions.

Here are the three plan options, what they require, and the testing implications:

Traditional 401(k): Employers have the flexibility to choose between not contributing at all, making outright contributions, or matching a portion of the wages employees’ defer. An employer can also set up these contributions with a vesting period. While it’s useful to set up your plan however you want, a traditional plan must pass nondiscrimination testing each year.

Safe Harbor 401(k): This plan type is similar to a traditional plan, but it requires employers to make contributions. There are very specific rules about how contributions are structured in these plans, and they usually must vest immediately. By committing to making these contributions, a plan gets to bypass nondiscrimination testing. Companies of any size can offer a Safe Harbor plan — if you want to learn more, check out our Safe Harbor 401(k) guide.

SIMPLE 401(k): SIMPLE is actually an acronym for Savings Incentive Match Plan for Employees. This plan type is allowed for businesses with fewer than 100 employees. Similar to the Safe Harbor plan, SIMPLE plans require employers to make contributions to their participants’ 401(k) accounts that vest immediately. SIMPLE plans are also exempt from nondiscrimination testing.

Step 2: Adopt a written plan
Once you’ve selected a plan type, you need to create a written document that — according to the IRS — “serves as the foundation for day-to-day plan operations.” That language may sound a little intimidating, but your 401(k) plan administrator will usually handle this paperwork for you.

Step 3: Arrange a trust fund for the plan's assets
A plan’s assets must be held in trust to ensure that they’re used solely to benefit plan participants and their beneficiaries. In other words, all those employee and employer contributions need to be kept in a safe place by a custodian and monitored by a trustee. A trustee is responsible for collecting the contributions, investing them as directed by the participants, and issuing distributions. This is also something your 401(k) plan administrator will typically handle for you.

Step 4: Develop a recordkeeping system
It’s important to maintain a reliable accounting of the activity in your plan. This step helps you keep track of contributions, earnings and losses, plan investments, the expenses, and the benefit distributions from participants’ accounts. Doing a good job will make the preparation of the plan’s annual return easy.

Step 5: Provide Plan Information to Participants
You must notify all eligible employees about your small business 401(k) plan (or any updates to it), typically 30 days before they go into effect. A summary plan description that you circulate usually serves as the primary way to share information about your plan and its benefits. If you include plan features like automatic enrollment, Safe Harbor, or a Qualified Default Investment Alternative, you may have to issue additional notices to your plan participants.


What are the fiduciary responsibilities for a 401(k) plan?
Once you’ve established your company’s small business 401(k) plan, there are a number of ongoing administration requirements. One of the decisions you’ll have to make as you set up a plan is who will act as your plan’s fiduciaries. Plan fiduciaries owe a duty of care to plan participants and beneficiaries to make sure decisions surrounding the plan serve their best interests. There can be many plan fiduciaries operating in different roles, such as plan trustee, investment manager, and administrator.

The IRS website outlines the key responsibilities for a 401(k) plan fiduciary. He or she must:

  • Act solely in the interest of the participants and their beneficiaries
  • Act for the exclusive purpose of providing benefits to workers participating in the plan and their beneficiaries, and defraying reasonable expenses of the plan
  • Carry out duties with the care, skill, prudence and diligence of a prudent person familiar with the matters
  • Follow the plan documents
  • Diversify plan investments

Many small businesses appoint outside vendors to oversee these responsibilities. Keep in mind, though, that hiring someone to perform fiduciary functions is itself a fiduciary act. That means you have a responsibility to select experienced professionals who are capable of carrying out all the duties above.

To ensure that your plan complies with Department of Labor (“DOL”) and IRS regulations, it’s a good practice to review it for common mistakes. The IRS even has a 401(k) Plan Fix-it Guide that calls out best practices. Here are some key compliance-related to-dos the IRS calls out:

  1. Update your plan document every few years to reflect recent law changes
  2. Stick to the terms of your plan document
  3. Make sure you’re defining compensation correctly for all deferrals and allocations
  4. Make sure you’re correctly matching the contributions of all eligible employees
  5. Correct a plan that fails the 401(k) ADP or ACP nondiscrimination tests
  6. Give eligible employees the opportunity to make an elective deferral
  7. Limit employee deferrals to the amounts specified in IRC Section 402(g)
  8. Deposit employee deferrals in a timely fashion
  9. Set up a loan policy that conforms to the requirements of IRC Sections 72(p) and 4975
  10. Make any hardship distributions properly
  11. Fix a top-heavy plan
  12. File a Form 5500 return for the plan annually

The IRS also provides a downloadable one-page 401(k) Plan Checklist that can help determine whether or not your plan is in compliance.

Investment selection
Most 401(k) plans allow their participants to choose how to invest the compensation they defer into the plan. These are commonly referred to as “participant-directed” or “self-directed” accounts. When your plan allows participants to make independent decisions about their investments, plan fiduciaries are protected from liability for the performance of the investments the participants have chosen for their accounts.

Here are the basic IRS guidelines for additional fiduciary protection for selecting investments on behalf of plan participants:

  • Give employees notice that they’re responsible for managing their own investments
  • Offer at least three diversified investment options with different risk/return factors
  • Give employees enough information about their options to make informed decisions

The information that should be available to employees includes:

  1. A description of each investment option, including the investment goals, risk and return characteristics
  2. Information about designated investment managers
  3. An explanation of when and how to direct investments and any restrictions on when participants can change investments
  4. A statement of the fees that the plan may charge to participants’ accounts when they change investment options or buy and sell investments
  5. Information about participants’ shareholder voting rights and the manner in which confidentiality will be provided on how participants vote their shares of stock
  6. The name, address, and phone number of the plan fiduciary or other person designated to provide certain additional information on request

You should also keep in mind that participant-directed plans can’t invest things like art, antiques, gems, certain coins, or alcoholic beverages. Investing in precious metals is only allowed if certain conditions are met.

How do I choose a small business 401(k) provider?
As we’ve seen, a lot goes into managing a 401(k) plan, so it shouldn’t be a big surprise that most businesses — big and small — look to a 401(k) provider to administer your plan and handle all the heavy lifting. When you start shopping around, there are three big-picture considerations: What tasks will the provider handle? How much will it cost you and your employees? And are there good investment options? If you do your homework to make a thoughtful, informed choice, it can mean everyone saves time and money.

Getting a little more specific, here’s what good providers usually do for employers:

  1. Integrate with your payroll: A seamless integration with your payroll system saves time, lets employees manage everything on their own, and eliminates duplicate data entry.
  2. Serve as a 3(16) plan administrator: Handle day-to-day management of the 401(k) plan, so you don’t have to deal with the headache.
  3. Act as a 3(38) investment fiduciary: Take on liability for your 401(k) plan, removing the pressure from you to always put your employees’ best interests first and to offer diversified, low-cost investment options.
  4. Offer matching and profit-sharing: You’ll want a plan that not only makes this possible, but easy to carry out. Even if you don’t intend to make employer contributions now, you may want to some time in the future (like if your plan fails nondiscrimination testing), so it should be easy to turn on profit sharing at any time.
  5. Keep employee fees low: Employees shouldn’t have to pay for the privilege of saving for retirement. Assets under management (“AUM”) fees from some providers often gobble up more than 1% of employees’ savings each year. Low-fee passive index funds often outperform pricier investments, and can carry fees as low as 0.06% across a portfolio.
  6. Perform ongoing compliance testing and reporting: Each year a 401(k) plan must pass a series of nondiscrimination tests that are designed to measure whether all employees have the same opportunity to participate. These include the ADP, ACP and Top-Heavy tests. Running these tests can be a big administrative burden, but a good 401(k) provider will handle them all for you — and provide Safe Harbor options that allow your plan to skip annual testing. Additionally, most small businesses look to their provider to file an annual report called Form 5500 with the IRS.
  7. Be easy to use: It shouldn’t take a Wall Street wizard to manage a 401(k) account. Look for a simple, straightforward employee experience that makes it simple to change and keep track of their accounts. The goal is to encourage employees to contribute to their 401(k), not to push them away because the experience is confusing.

If you want even more detail, we’ve put together a 401(k) plan checklist to help you compare providers. By choosing a provider that takes the lion’s share of responsibilities off your hands, you’ll worry less about all the details and focus on giving your employees a benefit that makes a meaningful difference as they save for their future.

What else should small businesses know about a 401(k)?
By now, offering a 401(k) probably sounds like a pretty good idea. And if you choose a good provider, it’s not hard. But there are a few more things you should know about:

You get tax advantages
One noteworthy aspect of 401(k) plans that we haven’t mentioned yet is the tax benefits for your company. The IRS lists the two primary tax advantages to sponsoring a program on their 401(k) Plan Overview page:

Your business pays less income tax because employer contributions are deductible business expenses (below certain limitations).
Your business can deduct the costs to set up and administer the 401(k).
Your business may also qualify for a Retirement Plan Startup Costs Tax Credit.

You can add profit sharing
Incorporating a profit-sharing component to your plan could help set you apart when you’re competing with other employers. Your business doesn’t technically need to have profits to offer ”profit-sharing” — it’s just another way you can contribute to your employees’ retirement accounts. By adding this feature onto your 401(k), you give yourself additional flexibility to decide how much to give employees every year. An employer can make contributions in Year 1 and take a break in Year 2, but then deposit more money in Year 3. The only requirement is that the employer must “have a set formula for determining how the contributions are divided” between employees.

Get started on your small business 401(k) plan today
Now that you know the basics, it’s time to jump in! Here’s the recap of things to consider when you shop for the perfect 401(k) plan.

What responsibilities will your provider handle? A good provider will act as a fiduciary, help with investment management, and deal with all the plan administration nitty gritty. Review items 1 through 7 above to make sure the provider you’re considering has you covered. If the provider you’re considering doesn’t offer all these services, you might end up with more on your shoulders than you bargained for. And if your current provider doesn’t handle all the tough stuff, you might consider shopping for one that does.

Is it easy for you and your team to use? Both employers and employees should have a good experience with your provider, their customer service, and any online apps. Pay close attention to the reps you talk to and ask them to walk you through the online experience to make sure it sure it all looks good. A difficult user experience or lack of human support can mean a lot more time figuring things out or helping your employees solve issues.

How much will a small business 401(k) cost your business? Guideline 401(k) starts at a $39 base fee plus $8 per employee per month. Guideline does not charge investment fees to participants.

When evaluating a small business 401(k), consider if there are hidden fees for key functions such as compliance, recordkeeping, and investment management. Also ask about setup fees, monthly fees, annual fees, Form 5500 fees, and whether a provider expects you to pay fees to anyone else. All these functions are covered by Guideline's standard pricing.

Are there any fees for employees? Many providers put a lot of the burden for their services on employees, or force employees into investments with high management fees. Ask what fees employees pay. Are there monthly fees or management fees? And what kind of fees are charged by the funds in their portfolios? For small business plans, the average employee fees are around 1%, but some providers have fees as low as 0.07%. Getting a good answer to this question could mean hundreds of thousands of additional dollars in each employee’s retirement account over the course of several decades.

If you want help keeping it all straight when you compare providers, check out our detailed checklist.


Nicolle Willson, J.D., CFP®, C(k)P®

Nicolle Willson, J.D., CFP®, C(k)P®

Head of Retirement Consulting at Guideline. JD, UCLA Law. Certified Financial Planner™. Certified 401(k) Professional™. Previously a financial planner with focus on retirement & estate planning.

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