Do you want to open a 401K for your company’s employees but don’t know how? If YES, here are 7 easy steps on how to start a 401K plan for your small business. If you are a small business owner based in the United States, then chances are that you have heard of the 401(k) plan.

But do you really understand what it means and why it’s important? Do you know how to get started with the plan even if you realize how beneficial it could be? If your answers to those questions are in the negative, then this article is for you, as it explains the basics you need to know about 401(k) plans, their importance, and how you can get started.

What is a 401(k) plan?

A 401(k) plan is an employer-sponsored retirement option that allows employees to contribute regulated funds into their retirement accounts. This contribution reduces an employee’s tax liability while allowing them to save for the days when they can no longer earn an income. When the employee reaches a certain age as determined by the law, they get to receive the contributions they made into their accounts.

Instead of offering pension plans that provide a fixed monthly income to retirees, many companies have switched to defined-contribution plans like 401(k) plans, which require employees to invest their own wages sometimes alongside that of the employer. Employers usually receive tax benefits for matching employee contributions, that is making some contributions into their employee’s 401k accounts.

Matching also provides a good incentive for employees to participate in the plan, and as such workers are more likely to contribute to a plan when an employer is matching contributions. In reality, setting up a retirement plan may be easier and more affordable than most employers think because many plans have no initial setup or maintenance fees. In addition, you may be able to get tax credits and other incentives for starting a retirement plan.

For example, any costs you incur during setup are likely eligible for tax rebates, and once your plan is up and running, employer contributions on behalf of employees are tax-deductible. It is a fact that a lot of employers already provide 401(k) plans to their teams.

The Society for Human Resource Management (SHRM) found that 94 percent of companies provided some type of retirement plan in 2016. Furthermore, 74 percent provided a match on some or all of their employees’ contributions to those plans. If others are doing it, then you too can do it. Here is how you can start.

Why is the 401(k) Plan Important?

A 401(k) plan helps to create a simple, tax-advantaged way to save money for retirement. So, by setting up 401(k) plans for your employees, you are sending signals that you really care about them and about what happens to them when they retire. This will motivate your employees to be more committed and to contribute more to the growth and success of your business.

So, when you set up a 401(k) plan for your employees, you are directly helping them plan a blissful retirement, and indirectly contributing to the growth of your own business. In addition, offering a 401(k) retirement plan for your employees is a smart way to help level the professional playing field between your small business and larger companies within your industry and beyond.

Aside the earlier stated advantage of motivation for your employees, a good retirement plan can help you attract talented people in today’s challenging job market (since they will only seek for jobs in companies that have long-term plans for them).

Another advantage of the 401(k) plan is that it can help you enjoy certain tax advantages that may be available to you as an employer offering the plan. So, your employees are not the only direct beneficiaries; you stand to benefit, too.

Factors That Would Help You Consider Which Plan is Right for your Business

  • The number of employees you have

Your employees are the first thing you should look at when you think of getting a 401k, because the number of employees you have would influence which type of plan you would get. If you have no employees other than you and your spouse or your business partner, and want the highest possible contribution limits, consider a Self-Employed 401(k).

If you have plans of hiring employees in the future, or you already have employees, you may need to choose between a SEP IRA and a SIMPLE IRA, both of which can cover employees.

After that, you would now have to decide whether you want to fund your employees’ accounts by yourself (SEP) or you want your employees to contribute (SIMPLE). Having all these details properly analysed would tell you which plan would be the best for your business.

  • How much you can contribute

After you have considered your employees, you now have to think about how much flexibility you want in terms of contribution limits and who you want to be responsible for making such contributions. A Self-Employed 401(k) plan offers the largest possible contributions because it recognizes that self-employed people can be both the employee and employer. In fact, as an employee, you can make elective deferrals of up to $18,500 for 2018.

As an employer, you can make a profit-sharing contribution of up to 25% of compensation, up to a maximum of $55,000 for 2018. If your business is not incorporated, you can generally deduct contributions for yourself from your personal income. If your business is incorporated, the corporation can generally deduct the contributions as a business expense.

The number of employees you have or have not would influence the kind of plan you will choose. If you have a business with variable income and you want more flexibility, you might consider a SEP IRA. Just remember that if you have employees in years you contribute, you have to contribute the same percentage for them as you contribute for yourself.

On the other hand, if you want your employees to help fund their retirement account, you may want to consider a SIMPLE IRA, available to businesses with up to 100 employees.

  • Ease of use

As a small business, you should never choose a 401k plan that is too complicated for you. Look for a simple, straightforward plan that makes it simple to change and keep track of your employees accounts. The goal is to encourage employees to contribute to their 401(k), not to push them away because the experience is confusing. Again, if you get a plan that is too complicated for you to manage, you run the risk of failing your annual tests.

Things You Need to Know Before Planning to Set up a 401k Plan for your Business

It is a fact that a lot of businesses entrust the setting up of their 401k plans to outsourcing firms. That in itself is not bad, and even if you too have decided to outsource yours, there are things you still need to know before you embark on this journey. They include;

  • Know how a 401k plan would benefit your business

Businesses set up a 401k for different reasons, and you need to know why your company needs one of such plans. Failure to do this would mean that you would not maximize the opportunities presented by it. If you need your 401k to be a tool that would allow you to be competitive in the market place, then design the plan in such a way that your employees are rewarded.

If you need it as a tool for retention, then build in safeguards and incentives that would tempt employees to stay at the company and with the plan. If you want it as a tool to compensate management, then do the company contributions so that they flow through to management in a way that is legit. You must also look into your employees demography before setting up a plan so you do not waste your time.

  • There are fees involved in the plan

Setting up a 401k plan comes with a fee, especially if you are a small business owner. If you fall into this category, then you need to budget around $1,500 to $3,000 to get a 401(k) up and running. It can even be more than that in some circumstances, and it can be lesser than that too.

Some of the fees that usually culminate in this amount include; administration fees, investment fees (which are deducted from the return of investment) and maybe even individual service fees that each participant in the plan has to pay. You would get to be informed concerning these fees once you ask. Some companies might be able to get the fee waived, but this is typically reserved for large businesses.

  • The 401k has different types

There are many types of 401ks in existence, but most employers offer either a traditional 401(k) plan or a safe harbor 401(k) plan. In a traditional plan, you contribute a percentage of income to each employee or match the amount your employees decide to put into their account.

You can even do both. You do, obviously, have to remain with the limits of the current tax law: $16,500 for people under 50, with people over 50 allowed catch-up contributions, up to $22,000 a year. The maximum total amount that can be contributed by you and your employee is $49,000.

The safe harbor plan is quite similar to the one above, but mandatory employer contributions must be fully vested when they’re made.

  • You would be required to go through annual testing

For traditional 401(k) plans, there is an annual testing that makes sure every employee can benefit from a 401(k) as they deserve. An employee making $110,000 or more a year is considered a highly compensated employee (HCE), and employers are required to test to ensure the benefits of the plan aren’t lopsided in favor of the HCEs over the non-highly compensated employees (NHCEs).

There are two tests to measure this: an actual deferral percentage test (ADP) and actual contribution percentage test (ACP). If those tests fail, the 401(k) could lose its tax-qualified status, and all contributions and earnings would have to be distributed to all the plan participants. If that happens, the low end of the salary employees may not mind, but your highest earners would be affected.

How to Start a 401K Plan for your Small Business in 7 Steps

Setting up a 401(k) plan for your business isn’t as complicated as you might think. In fact it’s never been easier for a small business owner to purchase a plan and get it started. Here are the steps involved in setting up a 401(k) plan for your business:

  1. Determine whether or not to get professional help

One of the first decisions you need to make when embarking on this type of project is whether you will set up the plan yourself or hire a professional to help you get your plan off the ground. Setting up the plan and maintaining it yourself will be more cost-efficient of course, but it could take up more of your time. Most small business owners find that it is easier and more cost effective to use the services of an outside professional.

A professional that can help you in this area may be a third-party administrator, mutual fund provider, or insurance company. If you are a small business owner, the best possible choice for you would likely be a third-party administrator. This might be the best option for you because your small business may not receive as much attention from a service that generally works with medium-size or large companies and corporations.

Employers who decide to use a third-party administrator can pick and choose from investment options. If you are a medium-size business owner, the best possible choice for you would be a mutual fund provider. These providers have a number of different plans that are available for you to use. They also have pretty low startup fees and yearly maintenance costs for their basic 401(k) retirement plans.

Although mutual fund providers are great for medium-size businesses, they are not the most suitable choice if you are looking for a more complex plan. If you are a large business owner, the best possible choice for you can be an insurance company. These companies are best for administration of complex retirement plans.

Insurance companies will offer you a variety of investment options, including mutual fund investment options if you are looking for higher growth requirements. However, these plans can be expensive to start up. This will not be a problem for your company if it is a large, money-making company. This is why it is more suitable for larger companies, as opposed to smaller companies who do not make a huge profit.

2. Figure out which plan is right for you

There are three types of 401(k) plans:
  • The Safe Harbor 401(k) plan
  • The traditional 401(k) plan
  • Simple 401(k) plan
  • The profit sharing 401(k) plan
i. Safe Harbor 401(k)

This plan type is much like the traditional plan type. The only difference is that employers are required to make contributions to their employees 401k accounts. By committing to making these contributions, a plan gets to bypass nondiscrimination testing. Companies of any size can offer a Safe Harbor plan.

The Safe Harbor plan, which is the most popular choice for small businesses with few employees, enables business owners to contribute the maximum deferral amount allowed without restrictions in exchange for providing a matching contribution to their employees’ accounts.

ii. Traditional 401(k)

In this type of plan, employers of small businesses are given the flexibility to choose between not making any contributions to their employees’ 401k accounts, making certain contributions, or matching a portion of the wages employees’ defer. An employer can also set up these contributions with a vesting period to ensure reduced employee turnover.

Employees can make contributions through payroll deductions. Nondiscrimination tests are usually carried out each year to ensure that business owners keep to their own side of the bargain. The traditional plan enables business owners to customize their plan. Business owners have more options regarding employer contributions, vesting schedules and even the choice to not match at all.

iii. SIMPLE 401(k)

SIMPLE is actually an acronym for Savings Incentive Match Plan for Employees. A simple plan is best for companies with 100 or fewer employees. Similar to the Safe Harbor plan, SIMPLE plans require employers to make contributions to their participants’ 401(k) accounts that vest immediately. SIMPLE plans are also exempt from nondiscrimination testing.

iv. Profit sharing plans

These are preferred by partnership businesses such as legal firms that reward employees based on the groups they fall within (e.g. partners, lawyers, and staff). There is also the less common individual 401(k) plan for self-employed small business owners.

3. Choose a provider and purchase your plan

There are many questions you need to ask about each provider before deciding to choose them or not. Has the provider made the process of buying a 401(k) plan simple or complex? Does the plan fit the basic needs of your employees? Can the provider manage your company’s investment roster? Will your employees’ fees be kept under one percent? Choose only a provider that answers these questions in the affirmative.

4. Put your plan down in a document

Once you’ve selected a plan type, you need to create a written document that would serve as the foundation for administering your business operations. Unless you hire a professional or financial institution to establish and maintain the 401(k), you will need to create a written plan document by yourself.

If a professional or financial institution is handling the plan for you, they will write the written plan. The written plan needs to have all the terms and conditions of your 401(k) plan. It is a legally binding document, so you might want to turn to a professional for help.

Your document needs to list what type of 401(k) plan you have decided on and what features you want the plan to have (i.e. employee eligibility and contribution amounts). You equally need to detail the process of contributing and distributing funds.

5. Define what percentage of salaries will be deducted

You and your employees will be able to select the percentage of salary to contribute from each paycheck. Most experts recommend 10% of the salary as a good starting point.

6. Adopt a trust fund for your plan’s assets

The aim of setting up a 401k plan is to collect contributions on behalf of your employees, and all those employee and employer contributions need to be kept in a safe place by a custodian and monitored by a trustee. When arranging the trust, you need to select a trustee.

This guarantees that the funds are only used by the participants and their beneficiaries. Deciding on a trustee is an important part of establishing a plan, as they must handle contributions, plan investments, and distributions.

7. Set up a recordkeeping system

You must come up with a way to keep track of employee and employer contributions, earnings and losses, plan investments, expenses and distributions. If you outsource the plan to a professional or financial institution, they will handle recordkeeping on your behalf. If you’re doing it yourself, you might consider using payroll software or SaaS payroll services. Your record keeping system is important for preparing annual reports, which you are required to do.

8. Inform your employees about the plan on ground

Once you have set up a plan and decided how to administer it, you need to inform eligible employees about their options and also educate them about how much money they might need during retirement.

Prepare a summary plan description (SPD) to distribute to qualifying employees in the 401(k) plan. This lets eligible employees know what to expect out of the plan. The SPD should have information on employee eligibility, contributions, when it is vested, distributions, claims, and employee rights and responsibilities.

9. Start enjoying the benefits

While the major benefits of setting up a 401(k) plan come in the long term, there are short-term benefits for your business, such as annual tax credits and deductions.

How to Maintain your Business’s 401(k) Plan

Choosing a 401k plan for your small business, and setting it up for use is just the beginning. To ensure that your plan continues to serve your employees and yourself, there are certain things you need to take note of. Depending on the type of 401(k) plan you choose to go with, you will need to conduct nondiscrimination testing, make employer contributions, report plan information, and keep up with fees. If not, you may incur penalties for yourself.

  • Your plan has to undergo annual testing

If you have a traditional 401(k) plan, it is subject to annual 401(k) testing to ensure all employees benefit, not just highly compensated employees. There are two types of tests you need to conduct: Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests.

These tests compare salary deferrals of highly compensated employees to non-highly compensated employees. The nondiscriminatory testing is basically used to keep employers in check. Should you fail this test repeatedly, you would incur penalties for yourself.

  • You have to remit contributions

Since you deduct 401k monies from salaries, you are required to make employer contributions if you have a safe harbor or SIMPLE 401(k) plan. Keep in mind that there can be penalties for late 401(k) contributions, so you have to ensure that your contributions are always timely.

  • Make your reports

For most 401(k) plans, you need to file Form 5500, Annual Return/Report of Employee Benefit Plan (Form 5500-SF or Form 5500-EZ if applicable). This annual return is done electronically. You need to distribute these reports to participants as well. You should also remember to give a summary of material modification (SMM) when your employees make changes to their information.

You should also distribute an individual benefit statement (IBS) to show plan participants their total benefits. One other thing you have to do here is to distribute a summary annual report (SAR) when you file Form 5500 so participants know that you reported to the IRS, and that your set up is legit.

  • Note your fees and dues

Keep in mind that the price you pay for a 401(k) plan doesn’t stop with setting it up. Typically, you are looking at paying plan administration fees, investment fees, and individual service fees. Record-keeping expenses generally range from 0.25% to 1% of the money in the plan, while investment-management expenses will vary depending upon both the manager and the investment choices. Add it up, and costs can easily reach 3%.

In addition, any plan with more than 100 participants must undergo an annual audit, which can add to the cost. There are also plans that charge a flat fee, like the Online 401(k) has plans for small businesses (up to 100 workers) that start at around $1,200 annually, plus a $4 monthly charge per employee.

Again, if the plan provider outsources a lot of the key functions including compliance, record-keeping, and investment advice, you could end up paying a lot in hidden fees. Look for a plan that does these in-house — and at the very least make sure you understand all the fees involved. Ask about setup fees, monthly fees, annual fees, Form 5500 fees, and whether a provider expects you to pay fees to anyone else.

Ajaero Tony Martins