Top 4 Benefits of Offering a Diversified 401(k) Plan

Author: Jay Jacob / Reviewer: Callie Adams Farnsworth, QKA, CAFCA
1 Jun 2023 / 401(k) Plan Information, Personal Finance, Small Business 401k

As a small business owner, you might think offering your employees a 401(k) plan is unnecessary. However, by offering a diversified investment option in your small business 401(k) plan, you can provide your employees with valuable benefits that can help you attract and retain top talent while also increasing your own financial security.

What is a Diversified Investment Option in a 401(k) Plan?

A diversified investment option is a type of investment that is designed to spread risk across multiple asset classes. In a 401(k) plan context, this can help your small business’s employees spread their savings across multiple funds, including stocks, bonds, and mutual funds. This approach can help reduce the risk of a single investment losing value, which is important for employees saving for the future.

Why You Should Offer a Diversified Investment Option

1. Increased Employee Engagement and Retention

Employees are more likely to stay with a company that offers a retirement savings plan that meets their financial needs. By offering a diversified investment option, you can show your employees that you care about their financial wellbeing, which can help to build loyalty and trust.

2. Reduced Fiduciary Liability

As a small business owner, you have a fiduciary responsibility to your employees to act in their best interest when it comes to managing their retirement savings. Offering a diversified investment option can help to reduce your fiduciary liability, as it allows employees to manage their own investments and make their own investment decisions.

3. Improved Retirement Outcomes for Employees

Diversification is a critical concept in investing, and it plays a vital role in 401(k) plans as well. By offering a diverse range of investment options within the plan, you can help employees reduce risk and potentially increase their returns over the long term. This, in turn, can contribute to their ability to save more money for retirement and achieve a more secure financial future. Here’s how diversification can have these positive effects:

• Risk reduction: Diversification involves spreading investments across different asset classes, such as stocks, bonds, and cash equivalents, as well as different industries, sectors, and geographic regions. The goal is to create a portfolio that is not overly concentrated in any single investment. By diversifying their investments, employees can reduce the impact of a single investment’s poor performance on their overall portfolio. If one investment performs poorly, others may offset those losses, helping to mitigate risk.
• Increased returns: Diversification also has the potential to increase overall investment returns. Different asset classes tend to perform differently under various market conditions. While one asset class may experience a decline, another may be performing well. By holding a diversified portfolio, employees have the opportunity to capture the positive returns of different investments. Over time, this can potentially lead to a higher average return compared to a concentrated portfolio.
• Long-term growth: The primary objective of a 401(k) plan is to provide employees with a vehicle to save for retirement. By offering a well-diversified investment lineup, you can help employees achieve long-term growth. Diversification helps to smooth out the volatility that comes with investing, as different investments may experience ups and downs at different times. This stability can instill confidence in employees, encouraging them to stay invested and maintain their contributions over the long haul.
• Preservation of capital: Diversification can also play a role in capital preservation. By allocating investments across different asset classes, employees can avoid the risk of a significant loss in their retirement savings. If a particular investment suffers a substantial decline, the impact on the overall portfolio can be minimized by the presence of other investments that may be performing well. This can help employees protect their capital and avoid severe setbacks as they progress towards retirement.
• Enhanced retirement readiness: Ultimately, the aim of a 401(k) plan is to help employees save for retirement and achieve financial security. By offering a well-diversified investment lineup, you empower employees to make choices that align with their risk tolerance and investment goals. Diversification helps create a balanced and resilient portfolio that has the potential to weather different market conditions. As employees accumulate savings through a diversified approach, they can be better prepared for a financially secure retirement.

It’s important to note that while diversification can help reduce risk, it does not eliminate it entirely, nor does it guarantee investment success or protect against losses.

Employees should be encouraged to regularly review and rebalance their portfolios based on their individual circumstances and investment objectives. Providing education and resources on the benefits and principles of diversification can help employees make informed decisions and take advantage of the potential long-term benefits it offers.

4. Increased Tax Savings for Business Owners

Offering a 401(k) plan with a diversified investment option can also provide tax savings and other benefits for small business owners. By offering a match and contributing to the plan on behalf of employees, you can reduce your taxable income, which can help to lower your overall tax bill.

Bonus: Did you know there are tax credits and deductions available to small business owners offering 401(k) plans? Now you do. Here are the details:

• Eligible employers can receive a tax credit of up to $5,000 over three years for starting a 401(k) plan, subject to IRS requirements.
• Employers with 50 or fewer employees qualify for a 100% tax credit, while those with 100-50 employees can receive a 50% tax credit.
• Additional eligibility criteria include having at least one non-highly compensated employee, an employee who received at least $5,000 in compensation in the preceding year and having substantially the same employees receiving contributions or benefits from another plan sponsored by the employer, a member of a controlled group, or a predecessor within the three tax years prior to becoming eligible.
• Employers with automatic enrollment plans can receive an extra tax credit of $500 per year for a three-year taxable period.

 

Ubiquity is not a registered investment advisor, and the information provided herein should not be considered legal or tax advice. We recommend consulting with your financial planner, attorney, and/or tax advisor for personalized advice.