The small business guide to 401(k) retirement plans
Offering a 401(k) sends a great message to your employees. It says that you’re truly invested in their future with your company—and beyond. They can help employees save for retirement, while potentially providing your business with tax savings and a valuable recruiting and retention tool. Studies show 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 offering a small business 401(k) can have a big impact on the way your employees think about your company.
How many employees do you need to have a 401(k) plan? Can small businesses even offer a 401(k)?
Let’s get this out of the way. Yes, any size business can offer a 401(k) plan. Traditionally, 401(k) providers charged small and mid-sized businesses exorbitant fees or ignored them altogether—leading millions of smaller businesses out in the cold without an easy way to offer meaningful retirement benefits. Guideline is changing that by offering small businesses an easy, affordable 401(k).
How do I set up a small business 401(k)?
If you’re ready to set up your small business 401(k), these are the four steps you’ll need to take.
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.
- Choose a plan that meets your business goals
- Pick your dream team
- Make it official
- Keep it running smoothly
Plan design options
The big difference between 401(k) plan designs is how and when an employer makes contributions on behalf of its employees. Here are three types of plan designs, their requirements, and some other implications:
1. Standard profit sharing 401(k) plan: This plan gives employers the flexibility to make outright contributions to employee accounts, make contributions contingent on what employees’ defer (i.e., matching), or not contribute at all. An employer can also set up these contributions with a vesting schedule. These plans are subject to annual IRS nondiscrimination tests.
2. Safe Harbor profit sharing 401(k) plan: This plan type is similar to a standard profit sharing plan design, but it requires employers to contribute to their employees’ accounts. There are very specific rules about how contributions are structured in these plans, and contributions usually have to vest immediately. But in exchange, these plans get “safe harbor status” and are exempt from some annual IRS nondiscrimination tests and the consequences of failure. Standard plans must pass these tests every year. Check out our Safe Harbor 401(k) guide for more details.
3. SIMPLE 401(k): Businesses with fewer than 100 employees can open a SIMPLE 401(k). 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. Read more about how the differences between 401(k) and SIMPLE plans.
What other 401(k) plan features should I consider?
Offering retirement benefits is a great way to attract and retain talent. But specific plan features can really boost participation and make your small business 401(k) plan even more enticing.
Traditional vs. Roth 401(k). What’s the difference?
Generally speaking, the key difference between the two is when employee contributions are taxed. With traditional accounts, contributions are made before taxes are taken out of pay. Under Roth accounts, contributions are taxed first and then deposited. When an employee retires, withdrawals from traditional accounts are taxed at ordinary income rates, whereas Roth withdrawals can generally be made on a tax-free basis.* Read more about traditional vs Roth accounts.
Should I match employee contributions?
Matching contributions can be hugely beneficial for both employees and employers. For employees, they’re an additional form of compensation that can help maximize their retirement savings. For employers, matching contributions may be tax deductible as an ordinary business expense, up to the annual corporate tax deduction limit on all employer contributions (25% of covered payroll).* Vesting schedules can help small business owners further customize their plan design to meet their business goals. Read more in our guide to 401(k) matching.
What is 401(k) profit sharing?
Profit sharing works like a bonus to an employee’s retirement account—with one big difference. Rather than be taxed immediately on that bonus, profit sharing contributions go straight into eligible employees’ retirement accounts without any tax taken at contribution. 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.
Small business 401(k) plans can involve a lot of different service providers and advisors. When setting up your plan, you can choose to take an a la carte approach with several different providers. Or find one provider who can handle most, if not all, of the services required to set up and administer your plan.
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.
No surprise: small business 401(k) 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. 401(k) recordkeepers are responsible for the following, to name a few:
- Logging employer and employee contributions
- Tracking investments
- Processing 401(k) loans and withdrawals
- Basic customer support
Financial advisors and fiduciary responsibilities
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 do the heavy lifting in selecting and maintaining investments for your plan and hopefully provide you with advice to make better decisions on your own. 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 money management for your plan. That means they also take on liability for investment selection and sometimes asset management. Your duties are limited as a plan sponsor to prudently select and monitor a fiduciary. Therefore, opting for a 3(38) investment manager might be the best decision if you aren't well versed in how retirement plans work.
401(k) third party administrators
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). But 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. Read more about 401(k) administrators.
What’s the difference between a trustee and 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, your 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.
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. Choosing a 401(k) provider that fully integrates with your HR and payroll providers can save time and reduce errors.
Guideline integrates with top payroll providers, including but not limited to the ones above.
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 the benefits, rights, and features under your plan. Your 401(k) plan administrator will usually handle this for you.
Your plan documents should include the following features, for example:
- 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.
For many plan designs, you’ll need to notify eligible employees about the 401(k) plan before it goes into effect—usually 30 days in advance. 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.
A sample go-live timeline with Guideline.
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.
Ongoing nondiscrimination testing
Offering a retirement plan 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. Most 401(k) plans are required to pass 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. Your company may also want to regularly review or revise your plan features as the company's situation changes.
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.
How much will a small business 401(k) cost?
Guideline 401(k) starts at a $49 base fee plus $8 per employee per month. Learn more about our fees and services here.
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 standard services are included in Guideline's 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.
There’s a lot to consider when setting up a small business 401(k). If you’re currently researching providers, our checklist can help you keep everything straight. If you’d like to learn more about Guideline, you can schedule a plan consultation.
*This content is for informational purposes only and is not intended to be construed as tax advice. You should consult a tax professional to determine the best tax advantaged retirement plan for you.