Author: Charles Crowley, CFP® AIF®
If you’re a small business owner, chances are you’ve thought about your employer 401(k) offering recently, especially if your business has grown. With more employees comes more responsibility to help them prepare for their retirement years. So, maybe you’re looking to optimize your current offering. Or, perhaps you’re looking to set up a 401(k) plan for your small business for the first time. How do you set up a 401(k) plan? What are the benefits of a 401(k) for your employees? And how much might it cost to offer one? In this blog, we’ll break down everything from helpful tips to follow when getting started to which states require employers to offer a 401(k) plan.
What is a 401(k) Plan?
Before we discuss setting up a 401(k) plan for your small business, let’s quickly refresh on what they are. Simply put, a 401(k) is an employer-sponsored retirement plan. Employees have the option to invest a certain amount of their weekly, bi-weekly, or monthly earnings before taxes are taken out. In 2024, the IRS set a limit of $23,000 per fiscal year. There are even recent rules that give investors the power to force $76,000 into a tax-free status. This allows employees to build their wealth over time tax-free if their investments perform well. There are three main options for small business owners to decide from:
- Traditional 401(k) Plan: If flexibility is important, a traditional 401(k) offering at your small business could give you and your employees the choice to contribute, match, both, or neither.
- Safe Harbor 401(k) Plan: Another option to consider when setting up a 401(k) plan for your small business is a safe harbor. Compared to a traditional plan, employer contributions and matches are mandatory.
- Automatic Enrollment 401(k) Plan: Finally, an automatic enrollment plan allows small business owners to place their employees’ salary contributions into default investments unless the employee elects otherwise.
Why Setting Up a Small Business 401(k) is Important
As a small business owner, the chance to offer an employer 401(k) plan is a great way to attract and retain top talent in the workforce. For job seekers, a robust 401(k) for employees can contribute to their long-term financial security, potentially reducing turnover rates. On top of the benefits of a 401(k) for employees, setting up a 401(k) at your small business can bring many tax breaks, including the deduction of employer contributions and company matches, saving you money in the long term.
Are You Required to Offer a 401(k)?
Although setting up a 401(k) plan for your small business can be a win-win for you and your employees, only a certain number of U.S. states require it. If your business currently operates in California, Connecticut, Illinois, Maryland, New Jersey, or Oregon, you will need to establish some form of a retirement plan for your employees. Anywhere outside of those six states, the decision is entirely yours.
How to Set Up a 401(k) Plan
Once you’ve decided to set up a 401(k) plan for your small business, there are several key steps to follow. From pre-planning to benchmarking, it is important to ensure you keep an active eye on your plan, as market conditions and other economic factors could shift at any time.
- Solidify Your Plan
Employer 401(k) plans are designed to be flexible, so ask yourself which type of plan you want to offer. Do you want to go with a traditional plan? Do you prefer the safe harbor option? How much would you be willing to match when employees contribute? These are just a few of the questions you can ask yourself when planning to set up a 401(k) plan at your small business.
- Find a Trust
One of the most important steps in setting up a 401(k) plan for your small business is arranging a trust for the plan’s investments and assets. The trust will be required to have at least one trustee, so it is important to partner with an advisor or financial management firm like BIP Wealth that you trust.
- Officially Document Your Plan
Once you’ve established which 401(k) route you will follow, you must put together official documentation that will be provided to the IRS. This document should include information such as which employees are eligible, how you will match contributions, and more.
- Encourage Employees to Participate
Once your employer 401(k) is up and running, be sure to market it to your employees. Share educational materials, answer any questions your employees may have, and discuss the benefits of participation. As a mutually beneficial offering, a higher participation rate could lead to higher tax breaks for your small business.
- Leverage Benchmarking
After setting up a 401(k) plan for your small business, you will have plenty of opportunities to optimize your plan. Through benchmarking, businesses evaluate and compare the performance of their 401(k) plans against industry standards and data. This can help you find areas for improvement and even cut costs.
FAQs
How much does it cost to offer a 401(k) for employees?
This will vary depending on the number of employees you have, administrative fees, and more. It is safe to assume you will spend anywhere from thousands to tens of thousands of dollars to successfully offer a 401(k) plan.
How do I set up a 401(k) as a small business?
If you’re considering setting up a 401(k) plan for your small business, start by establishing your preferred plan (traditional, safe harbor, automatic renewal, etc.).
What are the benefits of a 401(k) compared to other retirement plans?
A 401(k) is a great way for small business owners and their employees to build retirement wealth tax-free. Compared to other retirement plans, a 401(k) will only be taxed when money is officially withdrawn.