Getting Started With a 401(k) Plan
According to the Employee Benefit Research Institute, 93% of employers with more than 500 employees offer a 401(k) plan. Smaller employers need to be able to compete for the best talent by offering similar benefits. Fortunately, it's easier now more than ever for small businesses to compete for top employees by offering quality 401(k) plans of their own.
You can even start one for yourself if you are sole proprietor, or if you are the owner/operator of a corporation or LLC with yourself or a spouse. The 401(k) is flexible, powerful and efficient enough to be a compelling option for nearly any small business.
Where Does One Get Started?
Usually, businesses get started by approaching the owner's financial advisor or insurance agent. That's generally a great way to go because a live agent or advisor can tailor advice to your specific business and family situation. But whether you go to your agent/advisor or to a large online portal, you will soon have to make some key decisions:
What Kind of 401(k)?
Three basic 401(k) varieties:
- Traditional. These are generally well suited for businesses with more than 15 employees, or where rank and file employees will contribute at least 7 percent of their incomes to the plan. The traditional 401(k) can also work well for seasonal businesses. Employers may make matching contributions to workers' accounts, but is not required.
- Safe-harbor. These plans are well suited for small businesses with fewer than 15 employers. These plans allow owners to make the maximum allowable contribution to owner and management accounts, as long as the company also contributes to worker accounts on their behalf.
- Tiered Profit Sharing 401(k) s. These plans are well suited to companies with complex, multi-tiered compensation structures. The employer can assign a different percent of salary as a profit share for different workers, or categories of workers, as a profit-sharing plan.
Consider a Roth Option
Historically, 401(k) taxation has been similar to traditional IRAs: Contributions are made with pre-tax dollars, balances grow tax-deferred, and distributions are taxed as ordinary income.
In recent years, though, having "designated Roth accounts" within 401(k) plans have been increasingly popular. With these accounts, contributions are made after tax. That is, employees must pay income taxes on the amount contributed. However, after that point, there is no tax due on the growth, and distributions in retirement are also tax-free.
This can be a good option if you are concerned about estate taxes at death, or if you simply expect you are likely to be in a higher tax bracket in retirement than you are now. They tend to work better for younger workers. However, some experts believe there is some legislative risk associate with Roth accounts- future Congresses cannot be relied upon to honor the tax break.
You will want to decide what options you want available in your plan. Most plans offer a variety of mutual funds. It will be up to you and your advisor or agent to determine the precise mix of funds and other options in your plan. Some categories to consider include the following:
- Domestic U.S. Stock Funds
- Small-Cap Stock Funds
- International Funds
- Bond Funds
- Money Market Option
- Guaranteed Investment Contracts (GIGs)
- REIT Funds
- Precious Metals
- Brokerage Window
- Self-Direction Option
Note: Not every plan provider will offer all of these options. Some excellent plans will offer only a few of them.
Enrollment Policies and Rollout
Businesses need to consider what employees are eligible and how you will get them to participate in the plan. Will the default be to enroll them unless the 'opt out?' or require them to opt in? Understand that depending on the plan, owner contributions to your own plan may be limited if you do not get sufficient participation among the rank and file. (Note: This is not a concern among the self-employed!)
Will you make matching contributions to encourage workers to participate? What will the match be? Can you sustain that figure? Or are you likely to be forced to cut back on the match during a business downturn.
There are generally some setup costs as you get your plans rolling. However, Congress has authorized a tax credit of up to $500 per year for three years to offset any costs associated with setting up a retirement plan.
For more information on selecting the right 401(k) plan for your business or to get started discuss your options with an agent.