How to Reap the Benefits of Your Small Business 401(k) Plan
One big benefit of small business 401(k) plans – from the employer’s perspective – is that virtually all retirement plans offer significant tax benefits to the business and business owners.
These include the ability to deduct contributions from taxable income; the ability for employers to contribute to their own retirement at a higher maximum limit; and for certain eligible employers, take a tax credit up to $5,000 per year for three years.
A retirement plan also provides tax benefits to all who participate in the plan, not just employers. Contributions and investment earnings are not taxed until taken out of the plan. A 401(k) plan can allow after-tax Roth contributions, which will be taxable when you contribute them to your plan account – but are tax-free if not withdrawn until you retire. Savers credits are also available for those who qualify.
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But first things first. There are a few things to know before you can really get the most out of your 401(k) plan:
Understand 401(k) plans.
It’s crucial to understand what a 401(k) plan is and how it works. A traditional 401(k) is a retirement plan that allows employees to save a portion of their pre-tax income. The funds are invested in various assets, such as mutual funds, stocks, and bonds. Contributions to a 401(k) plan are tax-deferred, meaning employees don’t pay taxes on the contributions or the earnings until they withdraw the funds during retirement. In a Roth 401(k), contributions are made after tax, which means you only pay taxes on any interest earnings when you take a distribution (a.k.a., make a withdrawal) in retirement.
Maximize your small business’s 401(k) plan benefits.
The earlier you start contributing to a 401(k) plan, the more time your contributions can grow. Encourage your employees to start contributing to their 401(k) plan as soon as they’re eligible, even if it’s just a small amount.
The beauty of early contributions is a little something called compounding interest. This is when you make a contribution and it earns interest. Then that interest becomes part of the total – and it earns interest too! Over time, compounding interest can create an impressive addition to your complete retirement savings picture. The longer you’re saving, the more opportunity your money has to grow.
Consider matching a portion of your employees’ contributions to the 401(k) plan. This incentivizes your employees to save more (and demonstrates your commitment to their financial future). While this may seem like a way to give money away, it’s also a way to get tax credits.
Increase Contribution Limits
The IRS sets contribution limits for 401(k) plans each year. Consider increasing your plan’s contribution limit to allow your employees to save more money tax-deferred.
Offer Roth 401(k) Contributions
A Roth 401(k) allows employees to make after-tax contributions to their retirement savings. The contributions grow tax-free and can be withdrawn tax-free during retirement.
Automatic enrollment ensures that all eligible employees are enrolled in the 401(k) plan unless they choose to opt-out. This increases participation and ensures that all employees have access to the plan. Automatic enrollment is required for most plans as of December 20, 2022.
Offer a diverse selection of investment options to your employees, including target-date funds, index funds, and mutual funds. Ensure that the investment options are appropriately diversified and have low fees.
Provide financial education and resources to your employees to help them make informed decisions about their retirement savings. The Ubiquity blog is a great place to start!
Choose a reputable and experienced third-party administrator to help oversee your 401(k) plan. The administrator should offer excellent customer service, provide guidance on plan features, and ensure that the plan complies with all applicable regulations.
Ubiquity is not a registered investment advisor and no portion of the material herein should be construed as legal or tax advice. Please consult with your financial planner, attorney and/or tax advisor for advice.