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Benefits of a 401k for small businesses

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Last editedMay 20213 min read

If you’re a small business owner, it’s natural that you’re primarily focused on profit and growth. However, it’s also important to think about the financial wellbeing of your employees. There are a number of retirement plans to choose from, including various versions of a 401k. Here’s what you need to know about the best 401k plans, and whether they could be worthwhile for you.

Reasons to offer a 401k plan

Profit margins can be tight for small businesses, particularly if you’re just starting out – and there’s no denying that starting up a retirement plan is a major expense. But there are several 401k benefits to consider.

  • It makes your business more attractive to employees and can potentially boost retention rates.

  • Contributions to your employees’ plan is a tax-deductible credit. Some businesses can receive additional tax credits just for starting up a plan, all of which helps with expenses.

  • Traditional 401k plans offer deferred tax growth for all participants.

  • It safeguards your finances for the future, topping up government retirement accounts with your own money.

Types of 401k plans

There are a number of plans to choose from, catering to different business sizes and levels of flexibility. The best 401k plans will depend on your circumstances.

1. Traditional 401k

This is one of the most flexible options, available to businesses both large and small. You have the option to match employee contributions or contribute an amount of your choosing. One caveat is that annual testing is required to ensure that the benefits are offered equally to your employees.

2. Safe Harbor 401k

There’s less flexibility available with this type of 401k plan, but it comes without the testing requirements. Employers are also required to make contributions, which are vested immediately.

3. Individual 401k

As the name suggests, this popular 401k plan caters for individuals. It’s designed to support self-employed contractors or small business owners without any employees. However, business owners can also include their spouses in the plan if they help run the business.

How to start a 401k plan

If you’ve determined that the 401k benefits are sufficient for your business, the next step is to set up your plan. Here’s how to get started.

Step 1: Choose a provider.

Although you can administer your own plan, it’s easier to use a provider who can handle all of the administrative paperwork involved. Be sure to compare fees when shopping around, because these will come directly out of your employees’ retirement funds. It’s also useful to choose a 401k plan that works with your payroll process, so that deductions are taken automatically from paychecks.

Step 2: Determine your employer contribution.

Employees are more likely to sign up for your 401k plan if you offer employer contributions. While this can be a burden on small businesses, remember that your contributions are tax-deductible. Contributions are deposited directly into employees’ retirement funds. Contribution options include:

  • Non-elective: You’ll need to contribute a percentage of the employee’s pay into their account, whether or not they choose to contribute.

  • Matching: When the employee contributes to their retirement account, you match this contribution at a suitable rate. For example, you could opt to match $0.25 for every $1 that the employee contributes or choose a certain percentage. A typical amount is $0.50 per dollar for the first 6% of employee pay. 

Step 3: Be aware of 401k limits.

The IRS determines 401k limits when it comes to contributions. In 2020, this limit was set at $57,000 for employees under the age of 50. For employees over 50, the limit was set at $63,500. You’ll need to factor these limits into your calculations when choosing plans.

Step 4: Arrange a vesting schedule.

For business owners making contributions, it’s important to set a payment schedule. Vesting refers to the point when the account owner takes ownership of the funds. For safe harbor 401k plans, contributions are vested immediately – meaning they go directly into the plan owner’s account. However, with traditional 401k plans, there’s more flexibility involved. Employees might be fully vested when they’ve been with your company for at least five years, giving incentive to stay with the team.

Step 5: Share information with employees.

Finally, once you’ve signed up for a plan and chosen the level of contributions and vesting schedule, you need to disclose all of this information. Your plan provider can issue a summary description including all relevant information and sign-up details. This helps employees understand their rights, along with how they can make the most from the plan.

Although this sounds like a lot of information to sort through, in reality the benefits of a 401k plan outweigh any start-up headaches. You’ll help make yourself as well as your employees more financially secure, while at the same time making your business a more attractive one to work for.

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