How To Start a 401k For a Small Business

published by:
KENT GROFF, CFP®
March 4, 2021
How To Start a 401k For a Small Business

How To Start a 401k For a Small Business

When it comes to attracting top candidates and improving retention, offering specific advantages such as a 401(k) plan can be a practical move. But as a small business owner, you may have shied away from such benefits due to logistical and financial concerns.

If you're thinking about offering a plan for your employees, get started with these three steps.

Step #1: Research 401k Plan Providers

When researching plan options, it's beneficial to look for providers that will serve you and your employees long-term. If possible, ask other small business owners or local networks for recommendations. Hearing others' experiences can help you determine what to look for (or what to avoid) when choosing a provider.

It may be beneficial to look for fairly established, reputable providers adept at working with small businesses like yours. However, beware of high-cost plans, typically offered through insurance companies.

Step #2: Choose a 401k Plan

There are several types of plans that you can offer your employees.

Traditional 401(k) Plan

According to the Society for Human Resource Management, about 93 percent of businesses with a defined benefits plan offer a traditional 401(k) plan.1

This flexible option allows employers to make matching contributions, which can incentivize greater employee participation. The money employees choose to have automatically placed in their 401(k) is tax-deferred, meaning participants don't pay taxes on that amount until withdrawn.

It's important to note that traditional 401(k) plans are subject to annual nondiscrimination tests, called the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP).2 These tests are set in place by the IRS to determine whether or not employer matching contributions favor owners, officers, and high-income earners within that business.

Roth 401(k) Plan

This option is similar to a traditional plan. However, employees contribute with after-tax dollars. Therefore, withdrawals made in retirement will be tax-free. About 59 percent of businesses offering retirement plans opt for a Roth 401(k) plan (or similar defined contributions plan) for employees.1

Just like a traditional plan, you may choose to make matching contributions in a Roth 401(k) plan. Also, most providers can pair the Traditional and Roth 401k plans together.

Safe Harbor 401(k) Plan

A safe harbor 401(k) plan is relatively similar to a traditional plan, but there are a few critical variations. For example, Safe-Harbor employer contributions must be fully vested when made. Employers can choose to offer matching contributions only to employees who defer or contribute on behalf of all eligible employees.

Unlike traditional 401(k) plans, a safe harbor is not subject to the IRS's annual strict nondiscrimination tests (although your TPA will still complete these tests).

SIMPLE 401(k) Plan

SIMPLE 401(k) plans are designed specifically for small businesses as a cost-effective retirement plan option. Employers with fewer than 100 employees may use this plan, which acts similarly to a safe harbor 401(k) plan. Employer contributions must be fully vested when made. SIMPLE 401(k) plan providers are not subject to the annual nondiscrimination tests.

Automatic Enrollment 401(k) Plan

Unless the employees explicitly choose to opt-out or change their percentage, automatic enrollment - just as it sounds - automatically enrolls eligible employees into a 401(k).

Step #3: Find Your 401k Plan Partners

Once you have a better idea of what type of 401(k) you may want to offer employees, it's crucial to gather the right team to implement the plan smoothly and efficiently.

Potential partners may include:

  • 401(k) recordkeepers or plan providers: Recordkeepers are in charge of keeping track of the necessary details about your plan. This could include who is participating, what they're invested in, when money is added/removed, etc.
  • Third-party administrators: Having a third-party administrator allows business owners and small human resources departments to outsource the administrative work that goes into maintaining a 401(k) plan.
  • 401(k) advisor(s): Your 401(k) advisor can essentially take the lead on assuming the legal fiduciary responsibilities of your business's plan, as well as the heavy lifting involved with establishing a 401(k) plan. They can work with your employees one-on-one to answer questions about the plan and work to keep your plan fees down as you continue to grow.

As you begin to navigate your options, you'll want to choose providers and partners carefully, as they can make or break the effectiveness of your 401(k) plan. Your employees are crucial to your business's success. Establishing a plan that works in both their favor and yours is essential.

  1. https://www.shrm.org/hr-today/trends-and-forecasting/research-and-surveys/Documents/SHRM%20Employee%20Benefits%202019%20Investment%20and%20Retirement.pdf
  2. https://www.irs.gov/retirement-plans/plan-sponsor/401k-plan-overview

Have questions about your personal financial situation? Please contact us to discuss.

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