A small business 401(k) is an excellent way to show your team you care about their future.
Not only are 401(k)s ideal for boosting morale and sustaining a committed workforce, but they also offer benefits for your own retirement and tax savings. The time has never been better to start a 401(k), as companies with fewer than 100 employees will receive up to a $5,000 annual tax credit to offset the cost of administrative fees for the first three years.
To start a 401(k) plan for your small business, you’ll need to:
- Consider which plan you might want.
- Find the right 401(k) provider that meets your needs and goals.
- Determine whether you’ll match, create a plan document, and set up an asset trust.
- Devise a recordkeeping system.
- Let employees know about their participation options.
- Maintain your plan.
Consider which 401(k) plan you might want.
There are several types of 401(k) plans:
Many businesses choose the Traditional 401(k) to offer multiple investment options to employees and a way of saving for retirement with tax advantages. Many employers match employee contributions and deduct a portion of employee salaries from their tax obligations for the year. With a traditional plan, no tax is paid on the income put into the account at the time – but rather, tax is paid when money is withdrawn in retirement.
The 2022 limit is $20,500, plus $6,500 additional if you are age 50 or older and want to maximize your savings later in the game.
Most plans have the option of paying taxes when you put the money into the account rather than when you take it out. This is called a Roth contribution.
Like pre-tax deferrals, Roth 401(k) contributions are made to the plan by employees through payroll deduction. However, Roth contributions are deducted from wages after payroll taxes have been calculated. The investment earnings on Roth contributions grow tax-deferred while held in the plan, just like traditional pre-tax contributions. This money then has the potential to be withdrawn entirely tax-free when the saver hits retirement.
The 2022 limit for all 401(k) contributions is $20,500, plus $6,500 additional if you are 50 or older. This includes both Roth and pre-tax contributions.
Safe Harbor 401(k)s
A Safe Harbor 401(k) is ideal for high earners looking to invest aggressively in a retirement account. Unlike traditional plans, a Safe Harbor does not need to pass deferral and match discrimination tests to prove that it benefits all employees and not just highly compensated executives. Employers can choose to make a non-elective contributions of 3% or a match of up to 6%.
In 2022, business owners with Safe Harbor plans can contribute up to $61,000 plus $6,500 in catch up contributions for owners age 50 or older.
A SIMPLE 401(k) is a hybrid of an IRA and a 401(k). These accounts allow you to bypass compliance testing and enable employees to take out loans from their accounts, if necessary. Employees are immediately vested and there is less flexibility for employers to customize.
For 2022, the maximum contribution is $14,000 plus $3,000 in catch up contributions for people age 50 or older.
You can open a 401(k) for yourself (and a spouse or partner), even if you have no other employees as a sole proprietor, freelancer, or startup entrepreneur. You may make contributions as an employer and employee to maximize your tax-advantaged savings.
The contribution limit of $61,000 (plus $6,500 for people age 50 or older) in 2022 is higher than with a SEP IRA.
Find the right 401(k) provider that meets your needs and goals.
Still not sure which plan is right for you? Download our 401(k) guide to find the right 401(k) plan for your small business.
A 401(k) plan provider covers the administrative burden of establishing and running the plan, which can include:
- Employee support
- Loan administration
- Trust setup
- Tax filing
You can expect to pay a monthly charge for this service. Some 401(k) providers work with preferred brokers, while others offer the freedom to choose any broker. Depending on the broker, this financial adviser may choose the investments for the plan or help plan participants choose their own investments.
Determine whether you’ll match, create a plan document, and set up an asset trust.
Next, you’ll need to consider: How much do your employees want to invest in their 401(k)s? How much are you willing to contribute? Keep in mind, any contributions you make can be deducted as a business expense.
The maximum contribution is $61,000 for employees under age 50 and $67,500 for employees age 50 or older. Depending on the type of 401(k) established, certain rules may apply. You may choose to match 50 cents on the dollar, dollar-to-dollar, a percentage of salary, or up to certain limits.
All of this should be clearly spelled out in a legally binding plan document written by the financial institution and professional tasked with handling the plan. This document will also explain employee eligibility or vesting requirements, contribution amounts, and an explanation of how contributions and distributions will be made. A trust will need to be set up to hold the assets.
Devise a recordkeeping system.
You will need a system for tracking employer and employee contributions, earnings and losses, plan investments, expenses, and distributions. Many providers, including Ubiquity on most plan types, handle recordkeeping on your behalf. Otherwise, you may consider payroll software or SaaS payroll services.
Let employees know about their participation options.
Employees can only participate in your generous incentive if they know it exists. A plan provider can give you materials that describe the plan’s benefits, features, and employee rights, which you may then circulate. Employee seminars and presentations can be conducted to maximize participation.
Maintain your plan.
All plans require plan information reporting to employees, payment of plan provider fees, summary reports for plan participants, and completion of Form 5500 for the IRS.
Some plans may require Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) nondiscrimination tests that compare salary deferrals of highly-compensated employees vs. those of non-highly compensated employees.
How many employees do you need to have a 401(k) plan?
To offset the cost of administering a new plan, companies with fewer than 100 employees can receive up to $5,000/year in tax credit over three years (worth $15,000 in total). Plus, you can gain an additional $500 per year in tax credit over three years if you add an auto-enrollment feature to your plan. However, you can start a 401(k) plan even if there are no other employees other than yourself or yourself and your spouse!
It’s a common misconception that only large and mid-sized businesses can afford to offer a 401(k) to their employees in 2022. In the past, 401(k) providers charged small businesses exorbitant fees. Now, you can work with Ubiquity to find small business 401(k)s that are easy and affordable with one flat monthly rate and no assets under management fees – allowing you to grow your 401(k) without paying more.
How much should an employer contribute to the plan?
A common employer match is 50 cents on the dollar up to 6% of an employee’s salary. Another common match formula is dollar-to-dollar up to 3% of an employee’s salary. About one-quarter of small business owners offer no match at all, but may provide profit-sharing contributions on a good year.
What are the benefits of a 401(k) plan compared to other retirement options?
A 401(k) plan can offer your small business unique benefits when compared to other retirement savings plans. Consider:
Tax-advantaged retirement saving: The biggest advantage of choosing a 401(k) over other retirement options like the SIMPLE IRA, SEP IRA, or profit-sharing plan is the amount of tax-advantaged saving you’re allowed. Saving more creates a bigger retirement nest egg for your future, but also helps you save today. Saving tens of thousands of pre-tax dollars will take your taxable income down a few brackets, meaning you’ll be paying a lesser percentage of your income in taxes every year you contribute.
In 2022, individuals may contribute up to $20,500 to their 401(k) plans. Employers offering matching or non-elective contributions can increase this amount to a maximum of $61,000. Savers who are age 50 or older are also allowed a $6,500 catch-up contribution on top of these limits. Employers are allowed to set their own matching formulas, but they must pass annual non-discrimination tests to ensure fairness for all employees.
By comparison, the 2022 Traditional IRA limit is $6,000 with a $1,000 catch-up contribution allowed for those age 50 or older. You can set aside more with a SIMPLE IRA ($14,000 + $3,000 catch-up) or a SEP IRA ($61,000 + $1,000 catch-up). Here’s the caveat: though the SEP IRA has a high limit, only the employer may contribute to this limit, and whatever percentage of compensation employers wish to contribute to their own plans they must also contribute for each eligible employee.
Employer matching contributions: Matching contributions are a top benefit of 401(k) plans. Typically, employers will match a set percentage of their employees’ contributions. For example, a person earning $50,000 a year, with a 100% match up to 3% 401(k) plan, could expect to receive an extra $1,500 from the employer as long as the individual also contributes as much.
Eligibility: Anyone age 21 or older who meets the employer’s service requirements can save the maximum amount of money in a 401(k), no matter how much they earn. To contribute the full amount to IRAs, account holders must have a modified adjusted gross income worth less than $129,000 (single) or $204,000 (joint). Contributions begin phasing out above those amounts, and you can’t contribute once your income reaches $144,000 (single) or $214,000 (joint).
Investments: Participants in a 401(k) plan are typically limited to the investment options selected by their employers – typically a range of mutual funds – but these are relatively safe bets offering stable returns. IRAs typically allow greater investment choices, including a full suite of stocks, bonds, CDs, mutual funds, ETFs, and more. Yet, without investment knowledge, these options can be riskier.
Contact Ubiquity to find out how to get a 401(k) plan going in as little as 15 minutes.