If you’re planning on hiring employees, you may want to set up a retirement plan as a part of their benefits package. Generally speaking, small businesses will go with a 401(k) plan, which allows employees to put a portion of their pre-tax income into a retirement account and which allows businesses to contribute to that account (businesses have different ways that they can contribute, including matching employee contributions up to a certain amount). However, setting up a 401(k) plan can be a bit of a challenge if you’ve never done it before. The following is a beginner’s guide on how to set up a 401(k) plan for your business.
An Introduction To 401(K) Plans
Before going into setting up a 401(k) plan for your business, we’ll discuss the basics of what a 401(k) plan entails and why you should set one up in the first place.
What Is A 401(K) Plan?
At its core, a 401(k) plan is a retirement plan set up for employees that makes it easy for them to save money for retirement. The money that goes into the account is kept safe and monitored. The sponsor of the plan (the employer) provides employees with investment options that the money can go into. These investment options can include stocks, stock mutual funds, and bond mutual funds. Some companies will even add a profit-sharing component to their plan as an added benefit.
When you offer such a plan, the employee can choose whether or not they want to participate. If they do, employers can choose whether or not they want to contribute to the plan on behalf of their employees. Be aware that if you do contribute to your employees’ accounts,you must offer the same terms to every employee. The IRS requires yearly nondiscrimination testing to make sure you’re not rewarding some employees more than others through different sized contributions.
There are several 401(k) plan types to choose from, all of which come with numerous options:
- Traditional 401(k) – Traditional 401(k) plans give employers the flexibility to decide whether they want to contribute or not. They can also choose to contribute in several ways, either by matching part of the wages that their employees defer or make outright contributions. Employers can even set up contributions with a vesting period.
- Safe Harbor 401(k) – The biggest difference between a Safe Harbor 401(k) and a traditional plan is that employers must make contributions. There’s also not as much flexibility as to how those contributions can be structured–and they must be vested right away. However, Safe Harbor 401(k)s do not require annual nondiscrimination testing like traditional plans.
- SIMPLE 401(k) – SIMPLE (Savings Incentive Match Plan for Employees) 401(k) plans are essentially Safe Harbor 401(k) plans but for smaller businesses with fewer than 100 employees. They also require employer contributions that must be vested immediately and are likewise exempt from nondiscrimination testing.
Why Set One Up For Your Employees?
There are numerous benefits to setting up a 401(k) plan option for your employees. Here are a few of the important reasons why:
- Show existing employees that you care about their future – Setting up a 401(k) plan and contributing to it shows your employees you care about what happens to them after they retire and no longer work for you. This will provide them with more motivation to work hard and be productive. If you care about them, they will care about your company.
- Provide existing employees with an incentive to stay – Without a retirement plan, many of your existing employees will be more tempted to jump ship if a better employment offer comes along that includes a retirement plan. Replacing employees can be a very expensive process.
- Attract potential employees to your company – If you’re trying to hire highly-qualified individuals to work at your company, you have to be able to offer an attractive compensation package. If you don’t have a retirement plan set up, many potential employees may choose positions at other companies that do offer retirement plans.
Are You Required To Set One Up?
You are not required to have a retirement plan for your employees. Many businesses do not have retirement plans, especially businesses that have mostly entry-level or part-time workers on their payroll. There are also some alternatives to 401(k) plans, such as IRA (Individual Retirement Account) plans.
Who Decides On Which Key Factors?
Setting up a 401(k) plan requires that you make most of the decisions regarding certain choices; however, there are a few key factors that your employees will get to decide as well.
Factors Decided By You (The Employer)
Two of the most important factors concerning 401(k) plans come down to your decision: what type of 401(k) plan you decide to set up and who you hire to maintain your plan and to invest the funds on the behalf of your employees. There are many third-party administration services available, including insurance companies, brokerage firms, and mutual fund companies. The assets that the funds are invested in are often left to the discretion of whoever you choose as your fund manager, so do your due diligence to find a reputable service to manage your 401(k) plan.
Based on the type of plan you choose, you will also be able to decide how much you will contribute to your employees’ plans.
Factors Decided By The Employees
Employees can choose whether or not they even want to participate in your 401(k) plan. In some cases, employees may be living paycheck to paycheck and can’t afford to defer any of their income to a retirement account. If they can afford it, they get to choose exactly how much of their paycheck gets put into their account up to a certain limit.
As far as how their funds are invested, this is typically left up to the fund manager; however, some plans can allow employees the option of choosing between investing in long-term, aggressive investment strategies or more short-term, conservative options. It’s rare that the specifics of how funds are invested (such as into individual stocks) are left to the employees.
Employees have a certain amount of say into whether they can withdraw money from their account as well. If an employee has reached 59 1/2 years of age, has left your company, or has become disabled, they can begin withdrawing funds. In the event of their untimely passing, their beneficiaries must begin withdrawing funds as well.
Who Pays The 401(K) Fees
There are numerous fees involved with setting up and maintaining a 401(k) plan. Many of these fees are the responsibility of your employees–after all, it’s their money that’s being looked after and invested by fund managers. These include record keeping fees, investment management fees, advisory fees, annual administration fees, and individual service fees. However, as the employer, you can choose to cover many of these fees on behalf of your employees. Employers will often cover the administrative fees. These tend to be based on how many employees are participating in the plan. You will also need to pay for discrimination testing.
Employer Matching Of Staff Contributions
If you decide to contribute to your employees’ 401(k) accounts, you will also need to decide how you will match their contributions. A few key points to consider about employer contributions will help you choose how to match your own staff’s contributions.
How Much Is Standard?
The most common formula used by companies with 401(k) plans is to contribute 50 cents for every dollar that an employee contributes to their plan up to six percent of their pay. Some employers will even match 100 percent of their employee contributions up to a certain percentage. However, there are certain limits in place, which means that both employers and employees can only contribute so much every year.
Setting Contribution Limits
In 2019, the employer contribution limit was raised to $19,000 for employees aged under 50 and $25,000 for anyone 50 and above. Additionally, there is a maximum contribution limit for all contributions of $56,000 in 2019 ($62,00 for employees aged 50 and older).
However, it is not required that you reach the limit. You can set your own contribution limit. For example, maybe you only want to contribute 25 percent of what employees contribute. Some companies have lower limits because they are smaller and have less money available to contribute. However, you’re legally obligated to let employees know up front what the terms of your plan are, which means you will need to fine tune your budget so you know exactly what you can afford to contribute.
Many businesses implement vesting schedules into their 401(k) plans. A vesting schedule provides employees with an incentive to remain with the company for as long as possible. Vesting refers to how much of the employer contributions an employee can withdraw if they leave the company. Your vesting schedule will need to be at least as fast as the limits established for a 401(k) vesting schedule, which looks like this:
- Two years of service = 20 percent vested
- Three years of service = 40 percent vested
- Four years of service = 60 percent vested
- Five years of service = 80 percent vested
- Six years of service = 100 percent vested
If an employee leaves your company for another job opportunity after six years, they are entitled to all of the contributions you have made to their account. Your own vesting schedule can be more favorable to your employees, but it cannot be less favorable. Note that your employer contributions will automatically be 100 percent vested if the following occur:
- You terminate the plan
- You have an SEP, SARSEP, or SIMPLE IRA plan
- You have a Safe Harbor 401(k) plan
- Your employee has reached their normal retirement age
- Your 401(k) plan requires two years of service for eligibility
Other 401(K) Plan Considerations For Employers
As you can see, there are numerous decisions to make as an employer, including type of plan, who your fund manager will be, whether you will pay any of your employee’s plan fees, how much you’ll contribute, and what type of vesting schedule you’ll implement. However, there are a few more considerations that you will have to take into account when setting up a 401(k) plan, including the following:
As the sponsor, you have numerous legal obligations. These include the following:
- You must select, monitor, and (whenever necessary) replace the investment options offered to your plan’s participants. You can hire a fund manager to take on these responsibilities for you.
- You must provide your employees with sufficient information regarding the plan’s investment options so that they can make informed decisions regarding whether they want to contribute or how much they want to contribute.
- Every decision you make regarding the 401(k) plan must be in the best interest of your plan’s participants.
- You must document all of your actions and decisions regarding the plan to demonstrate compliance with ERISA (Employee Retirement Income Security Act of 1974) compliance.
- The investment selection and monitoring process must be documented in an Investment Policy Statement.
- You are not allowed to rely on investment recommendations made by non-fiduciary service providers.
- Every investment must be regularly monitored to ensure that it remains appropriate.
- If you don’t receive an annual written disclosure from your service provider within 90 days of the due date, you are required to notify the Department of Labor.
- If the contract provided by the service provider is unreasonable, you’re responsible for terminating it.
- You must update the plan when required based on new rules and regulations.
- You must inform plan participants of any changes that you make to the plan.
- You must make contributions in a timely manner–no later than the 15th business day of the month following the month in which the employee’s contribution was made.
If you do not follow rules and regulations governing the implementation and management of 401(k) plans, you will be subject to stiff fines and penalties as well as potential lawsuits from employees.
Tax Write Offs For The Business
Besides the benefits gained by your employees, a 401(k) plan also rewards employers for contributing money to the future retirement of their plan’s participants. This reward comes in the form of tax write-offs. Two main tax benefits that you can take advantage of by sponsoring a 401(k) plan include:
- You can deduct the contributions you make to your employee 401(k) accounts as business expenses on your tax returns, which can reduce the amount of income tax your business has to pay.
- You can deduct the costs of setting up a 401(k) plan as well as all of the fees involved with administering the plan.
- By setting up a 401(k) plan, you may be able to qualify for the Retirement Plan Startup Costs Tax Credit.
Learning how to set up a 401(k) plan can seem a bit challenging at first glance. As the employer, you have many responsibilities. However, if you do your research and find a good fund manager, setting up your 401(k) plan shouldn’t be too difficult–and once it is set up, it’s relatively easy to manage as long as continue following the rules and regulations. In the end, it’s well worth the trouble to reward your employees by helping them plan for their futures. Doing so not only shows you care, but will help with employee retention and will allow you to compete with other companies for highly qualified job candidates in the future.
Speak to an HR professional about helping you set up a 401(k) plan for your business today.