/ 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.

For small businesses that are ready to help their employees save for retirement, the IRS website covers the actions you need to set up a 401(k) plan. In case you don’t speak in tax code, here’s a more approachable step-by-step guide.

  1. Choose a plan design
  2. Choose a recordkeeper
  3. Decide whether you want a financial advisor
  4. Decide whether you want a third party administrator
  5. Choose your plan's features
  6. Adopt a written plan
  7. Open the plan trust account and appoint a custodian
  8. Provide plan information and education to employees
  9. Collect contributions through payroll after the plan starts
  10. Remember ongoing compliance obligations

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Step 1: Choose a plan design

The big difference between 401(k) plan designs is how and when an employer makes contributions on behalf of its employees.

The IRS has designed annual nondiscrimination testing to make sure the 401(k) plan a business offers is accessible and a fair benefit to all its employees. In general, if the 401(k) plan benefits favor highly paid employees or owners, plans will fail testing. Certain plan designs will allow employees to maximize their contributions while being exempt from annual nondiscrimination testing altogether.

Why does this matter? Not passing these tests could mean making expensive corrective contributions, administrative hassle, and potentially even needing to refund highly paid employees’ 401(k) account contributions at the end of the year. As an example, here are three potential plan designs, their requirements, and some of the testing implications:

Standard profit sharing 401(k) design: Employers have the flexibility to choose between not contributing at all, making outright contributions to employee accounts, or making these contributions contingent on what employees’ defer (i.e., matching). An employer can also set up these contributions with a vesting schedule. While it’s useful to be able to set up your plan in the exact way you want, a standard plan must pass nondiscrimination testing each year.

Safe Harbor profit sharing 401(k) design: This plan type is similar to a standard profit sharing plan design, but it requires employers to make contributions to employee accounts. There are very specific rules about how contributions are structured in these plans, and contributions usually have to vest immediately. By committing to making these contributions, a plan gets an exemption from certain nondiscrimination tests. Companies of any size can offer a Safe Harbor plan. It enables all levels of employees to maximize contributions without fear of testing failures and expensive corrections. If you want to learn more, check out our Safe Harbor 401(k) guide.

SIMPLE 401(k): SIMPLE is an acronym for Savings Incentive Match Plan for Employees. Despite the name, these plans can be quite complicated. SIMPLE plans are 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. However, they are very prescriptive about start and closure dates, and once you commit to contributions for the year you cannot change your mind. You can learn more about these plans here.

Step 2: Choose a recordkeeper

No surprise: Retirement plans require a lot of recordkeeping. Between all of the contributions, earnings, losses, plan investments, expenses, and benefit distributions, it’s a lot to keep track of. Your small business 401(k) plan recordkeeper is responsible for:

  • Logging employer and employee contributions
  • Tracking investments
  • Processing 401(k) loans and withdrawals
  • Basic customer support

Those are just some of the requirements that recordkeepers need to fulfill. Unless it’s bundled as an additional service, your recordkeeper isn’t there to serve as an advisor. They won’t alert you to compliance risks, help you design your retirement plan, or help you complete your Form 5500. Those responsibilities are left to other parties, as discussed.

When you offer a retirement plan through Guideline, we handle your recordkeeping, compliance testing, day-to-day plan administration, and more. That means your small business doesn’t have to sweat keeping track of disparate systems or vendors just to manage your 401(k) plan.

Step 3: Decide whether you want a financial advisor

In the context of retirement, there are generally two kinds of financial advisors that take on fiduciary responsibility: 3(21) and 3(38). These numbers refer to sections of the Employee Retirement Income Security Act (ERISA), the law dictating many of the rules surrounding retirement plans. Here’s how these “fiduciaries” differ:

A Section 3(21) advisor will take on co-responsibility in selecting and maintaining investments for your plan and hopefully provide you with advice to make better decisions. That said, you’re still responsible for calling the shots. If you don’t consider yourself a retirement pro, this approach leaves you and your company on the hook for bad or risky decisions.

A Section 3(38) investment manager has full control over your plan’s investment choices, and is the only one that can select of change the investments. That means they also take on full liability for investment selection and sometimes asset management.

In general, you as a plan sponsor have a duty to prudently select and monitor a fiduciary. That said, opting for a 3(38) investment manager might be the best decision if you aren't well versed in how retirement plans work.

Step 4: Decide whether you want a third party administrator

There’s a lot of behind-the-scenes work that needs to happen to keep your small business 401(k) plan in good standing. Though their responsibilities vary, 401(k) plan administrators generally handle:

  • Preparation of documents and notices for participants and beneficiaries
  • Approval of transactions (loans, distributions, etc.)
  • Monitoring compliance with plan rules and federal regulations
  • Discrimination testing and audit support
  • Compliance filing (Form 5500, etc.)
  • Generation of annual participant census

While 401(k) plan administration can be handled in-house, many choose to outsource the function to a third party administrator (TPA). That said, keep in mind that not all TPAs are created equal. If yours is an ERISA 3(16) fiduciary, they won’t just handle administration but they will also take on liability for doing these things in accordance with ERISA regulations. That approach can be an attractive option for small business 401(k) plans, thanks to the long list of 401(k) compliance deadlines and the steep fines associated with not meeting them.

Tip: You can work with recordkeepers, financial advisors, and TPAs separately—or with a retirement partner that bundles all three. The latter approach could be helpful for small businesses short on bandwidth. Guideline provides these services for a transparent, all-in-one fee.

Step 5: Choose your plan's features

Offering retirement benefits is a great way to attract and retain talent. But what are you doing to boost participation and make your small business 401(k) plan even more enticing?

Now is a great time to settle on your plan features. Will you offer access to both traditional and Roth options as part of your 401(k) plan? Generally speaking, the key difference between the two is when employee contributions are taxed. With traditional plans, contributions are made before taxes are taken out of pay. Under the Roth approach, contributions are taxed first and then deposited. With both, taxes are deferred until employees need to withdraw from the account. When that time comes, all withdrawals from traditional accounts are taxed at ordinary income rates, but Roth withdrawals can be made on a tax-free basis. The Roth option is often attractive to millennials and younger workers because they have a lot of time for their earnings to compound.

Another option, as discussed above, is to consider a Safe Harbor 401(k) plan. These are exempt from nondiscrimination testing (making it easier to stay compliant) but in turn require you to contribute to your employees’ 401(k) accounts. You can learn more about how these special plans work here.

Two additional features worth considering are employer matching and profit sharing. Profit sharing works like a bonus to an employees retirement account—with one key feature. Rather than be taxed immediately on that bonus, the entire amount goes straight into eligible employees’ retirement accounts without any tax taken. Employees won’t have to pay taxes on that money until they retire. For employers, these deposits are income tax-deductible and also aren’t subject to Social Security or Medicare taxes—making profit sharing a win-win for both parties.

Step 6: Adopt a written plan

Once you’ve settled on your plan types and features, you need to create a written plan document that, according to the IRS, “serves as the foundation for day-to-day plan operations.” While that language sounds intimidating, it’s just referring to a description of how your retirement benefits will work. (Note: your plan document may include all necessary details, or you may also have an adoption agreement, which is an easier-to-read checklist of features that goes along with the plan document.) Your 401(k) plan administrator will usually handle this for you.

Your plan documents should include the following features, but are not limited to:

  • When employees are eligible to participate
  • Vesting schedule information
  • Employer matching and/or profit sharing details
  • How distributions are handled
  • Contact information for the employer and applicable third parties

Getting this information right and making sure that it’s readily available is critical when you need to demonstrate compliance during an audit.

Step 7: Open the plan trust account and appoint a custodian

By law, your 401(k) plan’s assets must be held in a trust account to ensure that they’re used solely to benefit plan participants and their beneficiaries. In other words, our employees' money needs to be kept in a safe place by a custodian and monitored by a trustee. Keep in mind that custodians are the parties that actually hold your plan’s assets, while trustees are responsible for collecting contributions, investing them, and issuing distributions. These tasks can be delegated to a plan administrator, but the trustee will have ultimate responsibility to ensure the administrator is doing its job.

Step 8: Provide plan information and education to employees

For many plan designs, you’ll need to notify eligible employees about the 401(k) plan, usually 30 days before it goes into effect. Moving forward, you’ll also need to give notice of any changes. A summary plan description 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 be required to furnish additional notices.

You may also want to give employees a more thorough rundown of your retirement plan. Consider including a “Retirement 101” section in your next open enrollment presentation or all-hands meeting. Doing so could boost 401(k) plan utilization, promote financial literacy, and help dispel misconceptions employees might have about your overall benefits package.

Step 9: Collect contributions through payroll after the plan starts

Employees will contribute to their retirement accounts come payday. That means you’ll need to partner closely with your payroll provider to ensure employees’ personal information and retirement contributions are accurately reflected in all systems. When employees update their contribution rates in your retirement vendor’s platform, for example, this should feed into the tool you use to run payroll.

Guideline simplifies this process by integrating with your favorite HR and payroll tools, including industry leaders like Gusto, Zenefits, and ADP Workforce Now.

Step 10: Remember ongoing compliance obligations

Offering a retirement plan isn’t a “set it and forget it” proposition. It takes regular upkeep and a close eye on 401(k) plan compliance deadlines to ensure you don’t run afoul of ERISA and IRS rules. Your company may also want to regularly review or revise your plan features as the company's situation changes.

Nondiscrimination testing is just one compliance challenge. The IRS wants to ensure your 401(k) plan doesn’t favor segments of your workforce, like executives or highly compensated employees. That’s why most 401(k) plans are required to pass at least two types of nondiscrimination testing each year. These look at the value of each employee's account, employee contribution rates, and other details. Employer matching and profit sharing also come under scrutiny. Note that Safe Harbor plans are generally exempt from nondiscrimination testing.

In addition to keeping up with compliance testing, you’ll need to file an IRS Form 5500 each year. This federally-mandated form includes information about your business, your retirement plans, number of participants, and more. Note that there are three versions of the form. The version you need to complete depends on several factors, including how many participants your plan has and the value of its assets. After you’ve filed your respective version of the form, you’ll need to give plan participants a summary annual report, which is a high-level summary of the information on the Form 5500.


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.

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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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