401(k): What Small Businesses Need to Know

What is a 401(k) plan?

A 401(k) plan is an employer-sponsored benefit that allows employees to save money for retirement. According to the IRS, a 401(k) is a feature of a qualified profit-sharing plan that allows employees to contribute a portion of their wages to individual accounts. Employees typically have several choices for the types of investments the money is put into.

How do 401(k) plans work?

If a business offers 401(k) plans to its staff, an employee can sign up and designate a percentage of their paycheck to be placed into a retirement investment account. That money can grow significantly over the duration of the employee’s career and ultimately fund their retirement.

Eliza Badeau, vice president of workplace consulting thought leadership and commercialization at Fidelity, said that most workers are responsible for funding their own retirement in the current workplace environment. “We are shifting from an employer-funded pension plan to a defined contribution plan landscape. A 401(k) is a great way to save for the future.”

To boost participation, employers sometimes contribute to their team’s 401(k) accounts based on how much an employee contributes. For example, if an employee contributes 4% of their paycheck, their employer might match that contribution. This essentially doubles the amount the employee saves.

While the employer sponsors these plans, the money being invested belongs to the employee. The money they contribute to their account is theirs to take if and when they move on to a new job. As for the employer contributions, there is often a vesting period that requires an employee to stay with the company for a certain length of time before they can take that money with them if they land another job.

What are the benefits of offering 401(k) plans to employees?

There are significant benefits to offering employees a 401(k) plan. Even without matching contributions, offering a 401(k) plan allows employees to save pretax dollars for retirement. An employee can contribute up to $20,500 each year as of 2022. If a business owner matches the investment, the contribution amount cannot exceed $61,000 per year. That’s a big chunk of change that can help an employee prepare for retirement. 

Employees feel more loyalty to an employer that offers a 401(k) plan, particularly one that contributes with matching. This is a significant benefit to a company’s staff as well as to the company itself. Businesses can attract and retain top talent by offering perks like 401(k) plans and a robust healthcare package. 

“I think it is really important, if you are trying to grow your business, to think through offering a 401(k) plan and what that can mean to attracting and keeping talented employees,” Badeau said.

Employer contributions to employee 401(k) plans are tax-deductible, which helps the company financially. Some businesses may even qualify for tax credits. Plus, offering a 401(k) plan usually means that business owners are able to contribute a significant amount of money toward their own retirement. This helps business owners plan their own future and ensure their financial security. 

What are the types of 401(k) plans?

There are two types of 401(k) plans: traditional and Roth.

Traditional 401(k)

In a traditional 401(k) plan, the money an employee chooses to invest in the plan is pretax. This means the money they contribute comes out of their paycheck before taxes are deducted. However, they will pay taxes on the money when they withdraw it from their retirement account.

Roth 401(k)

With a Roth 401(k) plan, the money comes out of an employee’s paycheck after taxes have been deducted. That means they won’t pay taxes on the money when they withdraw it since it was paid upfront.

What are 401(k) alternatives for small businesses?

If you don’t feel comfortable offering a 401(k) plan, you have some other options for giving employees a way to save for retirement. Retirement savings education can be a more affordable means of helping your employees without directly managing retirement accounts for them.

A 401(k) is not the only option for small businesses looking to establish a retirement plan for their employees. Business owners should also consider SEP and SIMPLE IRA plans as potential alternatives. 

SEP IRA

A Simplified Employee Pension (SEP) IRA is a plan that allows an employer to put away up to 25% of their income to save for retirement. They can establish these funds for themselves and their employees. Contributions to a SEP must be made by the employer on behalf of the employee; there are no employee contributions. 

SIMPLE IRA

A Savings Incentive Match Plan for Employees (SIMPLE) IRA is a retirement plan that allows both employers and employees to contribute to an employee’s retirement savings. In a SIMPLE IRA, an employer must match up to 3% of an employee’s annual compensation or make a 2% non-elective contribution for employees, with an annual limit of $305,000.

There are also traditional and Roth IRAs, which are different from traditional and Roth 401(k) plans.

How do I set up a 401(k) plan for my business?

While a 401(k) plan is a benefit traditionally offered by larger organizations, Fidelity’s Badeau said that small businesses should strongly consider offering one too. “Many [retirement plan] providers have solutions that are great for small businesses,” she said. “Fidelity works with thousands of small businesses.”

Employers that want to begin offering 401(k) plans should follow these steps to get started.

1. Select a plan provider.

There are numerous financial institutions, like Fidelity, Charles Schwab and Merrill Edge, that companies can partner with. Another option is to work with a human resources services provider, like a high-quality payroll services provider or a top-rated professional employer organization. In addition to their core features, many of these HR providers offer 401(k) plan management.

“A payroll provider may be the best option, as they can process any necessary deductions automatically when payroll is run and eliminate duplicate data entry,” said a spokesperson for Gusto, a payroll and HR services provider. [Check out our review of Gusto.]

2. Check state regulations.

As to whether they can even offer a retirement plan to employees, some small businesses might not have a choice, depending on the state they operate in.

“Many states have passed laws which require employers to provide employer-sponsored retirement programs,” said the Gusto rep. “For example, California requires businesses with five or more employees to offer a retirement plan or provide access to a Secure Choice IRA through the state-run fund.”

Small business owners and entrepreneurs should research whether their state has any similar requirements and at what point they might take effect.

3. Analyze the 401(k) plan features.

Once you’ve decided which plan provider to partner with and confirmed your state’s regulations, there are some more decisions to make, including the number and type of funds you will offer.

“There are a lot of different features and functions,” Badeau said. “It all depends on [how] you want the final plan to look.”

One option is an automatic enrollment policy, where each employee is automatically enrolled in the 401(k) plan at a certain savings percentage unless they specifically opt out. Automated enrollment can lower the overhead costs of providing this benefit and make it easier to maintain for employees.

The biggest factor to consider is whether to offer matching contributions. While nothing requires employers to provide this added benefit, Badeau said it could pay off in the long run. “A well-designed 401(k) plan, with a company match and that incentive, can really help keep people and attract the right people [a business is] looking for.” 

In addition to paying off for the employer, matching contributions is a significant perk for employees. Badeau said that they incentivize employees to save more. “It is likely they will contribute enough to reach [the maximum employer contribution], so it encourages them to have a higher contribution rate.” 

While matching contributions can be a positive for employers and employees, there are some instances when it might not make sense to offer them. “If a company is not yet profitable or is going through a tight financial situation, for example, they may not want to match contributions,” said the Gusto spokesperson.

Another plan feature to consider is a professionally managed option. With this, employees have access to a financial advisor who will help them with fund selection and contribution amounts.

4. Determine the 401(k) costs.

For small businesses, the costs of offering a 401(k) retirement plan can vary greatly.

There are typically setup and maintenance fees, the latter of which are often based on the number of participating employees. Complete Payroll Solutions estimates the setup costs as between $500 and $2,000, with annual administration fees of $750 to $3,000.

It is essential to note that added plan features, such as automatic enrollment, increased fund options or professionally managed services, will probably increase a company’s costs. “It is important for employers to be conscious of those when considering [whether to offer a 401(k) plan],” Badeau said.

That said, some of these costs can be offset by certain tax deductions that small businesses with fewer than 100 employees may be eligible for.

“Some administrative fees are considered tax-deductible business expenses,” said the Gusto rep. “Small businesses may be eligible for the credit for small-employer pension plan startup costs, a tax credit of up to a maximum of $500 per year, which covers 50% of eligible setup costs to qualified retirement plans.”

What are the top employee retirement plan providers?

Finding the right employee retirement plan provider can take some research. Fortunately, we reviewed top providers to find the best business employee retirement plans for small businesses. See some of our recommendations below.  

Human Interest

Human Interest was founded in 2015 to help address a growing concern among Americans who needed to save for retirement. The company, headquartered in San Francisco, is appealing due to its affordability, with low monthly employer and employee fees. Its plans are flexible and can be customized to address an employer’s specific needs. See our full Human Interest review.

ADP

ADP, founded in 1949, is a popular payroll provider. On top of doing payroll services, the company also offers 401(k) account administration. Businesses can integrate with ADP payroll to make processing contributions automatic and easy. Employers will also appreciate the mobile app, which allows for easy enrollment of new employees. We found ADP to be one of the best service providers for small businesses. Be sure to read our complete review of ADP for more information.

American 401k

American 401k stands out for its transparency because the company lays things out in a clear way that’s easy for business owners to understand. They walk you through the 401(k) process and offer more than 15,000 funds and ETFs so employees can maximize their savings with diverse investment options. Each fund’s expense ratio is disclosed upfront so business owners can see the costs of the investments and make informed decisions. 

Kimberlee Leonard contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.