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A 401(k) is a benefit employers offer that incentivizes employees to save money for their retirement. Here's how to choose one for your business.
Retirement benefits like 401(k) plans give employees an advantage as they prepare for their retirement years. They’re also an excellent job perk that helps employers attract and retain the top talent needed to grow a business. Many types of 401(k) plans exist, including options for self-employed individuals. We’ll explain 401(k) plans and help employers assess their needs to choose the right plan for their organization.
A 401(k) plan is part of an employee benefits package that allows employees to contribute a portion of their wages to individual accounts to save money for retirement. The money is deducted from their paycheck and deposited directly into their 401(k) account.
Here are some notable facts about 401(k) plans:
Despite the availability of other types of retirement plans, 401(k) plans are highly recommended. “While MEPs [multiple employer plans] and state mandates are all the talk on an industry level, the 401(k) is still the best tried-and-true way to save at work,” said Andrew Meadows, senior vice president of human resources at Ubiquity Retirement + Savings. “With high contribution limits and the ability to lower costs, the 401(k) is becoming leaner and a more popular option for small businesses.”
Here’s a quick overview of the most popular types of 401(k) plans. (You can find a complete 401(k) plan breakdown on the IRS website.)
Considered the most flexible plan, a traditional 401(k) allows employees to make pretax contributions through payroll deductions. Traditional 401(k) plans are often offered with an employer match program. These contributions are not always vested, meaning employees do not own the matching contributions until they meet certain provisions:
This plan is similar to the traditional plan but mandates that employer contributions be vested as soon as they’re made. There are three types of safe harbor plans, two of which have employer-match provisions. Safe harbor plans are also not subject to the nondiscrimination tests that traditional 401(k) plans must undergo:
The Savings Incentive Match Plan for Employees (SIMPLE) 401(k) typically is a startup 401(k) plan. Only businesses with fewer than 100 employees can offer this plan:
A Roth 401(k) plan is funded with post-tax income, so money saved is not subject to any federal or state taxes as long as the investor reaches the age of 59 1/2 before withdrawal:
Solo 401(k) plans, also known as self-employed 401(k) plans, are for self-employed individuals or businesses with only one employee. They allow contractors and sole proprietors to have a retirement savings option. Self-employed individuals can choose the traditional or Roth structure for solo 401(k) plans:
With a profit-sharing plan, an employer sets aside a portion of its pretax income to share among its employees. This plan type provides flexibility in how much money the employer contributes. Several varieties of profit-sharing plans are under this umbrella, including pro-rata plans, new comparability plans and age-weighted profit-sharing plans:
A 403(b) retirement plan is a tax-sheltered account designed for teachers; it’s sometimes also used by eligible not-for-profit groups, including religious organizations. Contributions are pretax and earnings are not taxed until they are distributed:
While other 401(k) plans exist, many are more complex and are unlikely to suit small businesses. “Larger companies with a 401(k) may want a special variety for their type of business,” Meadows explained. “However, small businesses will likely want to keep it simple to avoid any complicated compliance worries.”
Meadows advises small businesses to provide the most robust 401(k) plan they can afford — and to implement one as soon as possible. “Today, there are more and more providers helping small businesses avoid high-cost funds and access manageable monthly administration fees,” Meadows explained. “This may vary from business to business, but the sooner you can set up a 401(k) plan, the better.”
To choose the best type of 401(k) plan for your business, determine the answers to the following questions:
When choosing the right plan for your business, you should also consider plan administration complexity and costs:
Small business owners typically have the following concerns about implementing a 401(k) plan:
However, according to Ben Smith, founder and Certified Financial Planner at Cove Financial Planning, 401(k) plans are viable options for many small businesses with numerous benefits. “Generally speaking, any business that seeks to provide a relatively simple and low-cost plan may consider a 401(k),” Smith asserted.
Additionally, a 401(k) plan can help your business attract and retain top talent. “One benefit for even the smallest businesses to have a 401(k) plan for employees is simply to attract and retain talent,” Smith noted. “Many job seekers and current employees will value the added benefit of having access to a retirement plan offered by their employer and they may look elsewhere for work if a business does not offer one.”
To allay any misgivings and get your employees on board with the plan, Meadows offers the following advice:
As business owners evaluate various options, it’s important to understand the differences between 401(k) plans and IRAs and how they relate to mutual funds.
Here’s how it works.
“401(k)s contain mutual funds, but the fees for those funds are lower than an individual could purchase on their own,” explained Cynthia Keaton, vice president of human resources at Secure HR Pro, LLC. “There is a requirement for company oversight, so there is a constant review of the funds to ensure they are the best options for employees. An individual who selects their own [mutual] funds does not have the advantage of this expertise monitoring the funds and a financial planner may have an incentive to keep individuals in higher-fee funds.”
Meadows defines a mutual fund as “the investments your pretax or post-tax dollars go into so that they can grow into a valuable nest egg for your retirement.”
In contrast, traditional and Roth IRAs are individual retirement accounts not tied to your employer. Only one person can be on an IRA account. The money also grows tax-free and a Roth IRA isn’t tied to an employer.
“This means that when the owner pulls money out in future years, it comes out tax-free,” Smith explained. This part of a Roth IRA is very similar to a Roth 401(k).
Social Security funds continue to be depleted and workers are increasingly concerned about the future of retirement.
Currently, one-quarter of Americans 65 and older receive 90 percent of their income from Social Security payments. However, the 2021 Social Security Trustees report found that, without any intervention, funds will run out by the mid-2030s. The report estimates that Social Security funds will only pay 78 percent of scheduled benefits at that time.
Roger Lee, co-founder of Human Interest, agrees that the United States has a looming retirement crisis.
Roughly half of Americans are only saving 10 percent of their annual income or less toward all of their financial goals, falling short of recommended retirement savings strategies.
“While it’s essential to have a discussion about financial responsibility and planning, it’s also important to recognize that many workers don’t have access to 401(k) plans, which has become the dominant means of saving for retirement,” Lee explained.
However, if you are one of the lucky people with access to a 401(k) plan, these plans have become the forerunner in addressing retirement needs.
“[Social Security] and pension plans are of the past,” said Brian Menickella, co-founder of financial services firm The Beacon Group of Companies. Menickella believes the financial future of retirement is bright, even with the continued concern around Social Security.
Choosing the best employee retirement plan for your business means examining your requirements and budget and finding an option that suits your employees’ needs. When selecting a 401(k) plan, find a reputable vendor with reasonable fees and excellent resources to guide you.
Consider the following top options when beginning the process of setting up a 401(k) plan for your team:
The most important thing to remember about contributing to a retirement plan is that the sooner you start, the better. This is true both for you and your employees. By creating a 401(k) plan for your business, you and your employees can start feeling more secure about your financial future today.
Sally Herigstad contributed to this article. Source interviews were conducted for a previous version of this article.