If you are self-employed, work part-time or if your employer does not offer a retirement plan, you will find out that it is not so easy to plan for your retirement when all the work is all up to you. However, if you work in an environment where your company sponsors a 401(k), saving for retirement is very straight forward. Your employer usually walks you through the process, and they take care of all the complicated administrative stuff. It’s too bad that not everyone will have the privilege of such due to one reason or the other.

To put it in really general terms, a 401(k) is a retirement savings account that is offered through your employer. Using this plan, you can set aside some amount of money each month from the amount of money you earn and then invest it through this account. You have the option of investing in a variety of assets (i.e. stocks, bonds, mutual funds). Over time, your money grows. Ideally, when you retire, you’ll have a big stack of money that’s been growing for years.

The money that you make through your 410k investments will not be taxed until you want to withdraw it, which will hopefully be when you have retired.

More and more people are finding that they have to take their retirement savings into their own hands. In times past, it was the norm to have well defined benefit plans in the form of pensions to support retirees when they stop working. These days, most people are left with defined-contribution plans like 401k plans. There’s also Social Security, but it’s not getting any more generous.

Why do You Need a 401k Plan?

A lot of people are of the opinion that saving for retirement is boring, but important, and you should do it as soon as you can. Even if you save as little as $50 a month it can go a long way. With a 401(k), your company might offer to match a percentage of some of your 401(k) contributions. This is basically free money. Also, since the money you invest is “pre-tax,” you could reduce your annual tax bill.

Another benefit that comes with a 401k retirement plan is that you can have taxes deferred until you withdraw the money when you retire. So, since the 401(k) actually reduces your tax rate, you won’t be paying taxes on the money until you withdraw it. Since a lot of people usually fall into the lower tax bracket when they retire, the 401(k) actually has you paying a smaller tax rate on your savings when you take it out of the account.

If you don’t have an account to contribute to, it’s time to start your own 401k or similar retirement savings program. The route you take will depend on your situation: you’re either

  • An employer (including a self-employed individual) who wants to set up a 401k plan for your business, or
  • An employee of a company that does not currently offer a retirement plan

If you fall into the second category (you’re an employee earning W2 wages), you may not be able to set the plan up yourself, but you have several options, which we’ll discuss below. 401k plans are employer-sponsored retirement plans, so they need to be set up by the employer. If your employer won’t play along (they might just need some nudging), you’ll need to take matters into your own hands.

So, in other words, you can’t just get a 401k for yourself if you are working in a company that does not offer it. By definition, a 401(k) is an employer-sponsored retirement plan designed to encourage employees to save money for retirement and employers to help them do it. So to take advantage of this type of an account, you need to have an employer, and the employer needs to be the sponsor of the plan. In addition, you can’t also invest in a 401k if you are unemployed.

But just as with many other topics in finance, there are exceptions. Here are two major exceptions to the 401(k) rules.

  1. You are the employer

The very first exemption is if you are self-employed and as such you are your own employer. In that case you can start a retirement savings account known as a Solo 401(k) or Individual 401(k).

Basically, you will get all the benefits of an employer-sponsored 401(k), as well as the ability to invest in any stocks, bonds, or mutual funds you want – not just in a small, specific basket of funds such as those that most employer-sponsored 401(k) plans offer.

If you qualify, an individual 401(k) can be a very good choice for your retirement savings. The contribution limits are high because you are the employer as well as the employee and as such you can contribute in both capacities. For the 2017 tax year, you can contribute up to $18,000 as an employee ($24,000 if you’re over 50) and another 25% of your income as an employer.

You have until April 15 of the following calendar year to make your contributions. For instance, contributions for the 2017 tax year can be made until April 15, 2018. Additionally, 401(k) assets are better protected from litigation than other forms of retirement accounts such as IRAs.

There is also another way by which you can benefit from an individual 401k. If you are an employee somewhere else (where you don’t already have a 401k) but you also have a business on the side, then you can also qualify to take an advantage of the plan.

2. 401(k) with former employer

The other exception is if you don’t have a 401(k)-offering employer, but you used to. If you should leave a job where you already have a 401k to another job, your former employer will generally allow you to leave your retirement assets in its 401(k) plan. Depending on the company, there’s usually a minimum balance requirement — many don’t allow former employees to leave accounts with under $5,000 in assets if they’re no longer employed with the company.

If you choose to leave your 401(k) with a former employer, you do lose some benefits, such as the ability to make new contributions. However, many 401(k) plans offer low-cost investment funds that are unavailable to the general public, so if you have an old 401(k), it may be a good idea to leave it where it is.

How to Start a 401k

Setting up a 401k retirement plan can be quite simple or complicated depending on your approach. Most people (and businesses) choose to outsource at least some portion of the process in other to ease up the burden involved. In particular, they use a “template” legal document to establish the 401k plan – because it’s a lot cheaper than hiring an attorney to reinvent the wheel for you. Unless your retirement plan is especially tricky or you’re trying to get fancy (and you have no shortage of money), you’ll probably use preconfigured programs from 401k vendors. These programs are often called “volume submitter” or prototype plans.

Most Important Pieces of a 401k Plan 

The plan document is a legal document that contains the rules and regulations that govern the 401k retirement plan. It contains the general rules governing the 401k plan, specific terms and it also serves as a roadmap for any question that come up when administering the plan. This document is usually lengthy. Typically, a summarized version of the document (known as the Summary Plan Description or SPD) is distributed to employees when they enroll in the plan.

The adoption agreement is a document that you have to make use of in order to setup your 401k retirement plan. The adoption agreement allows you to customize the plan so that it fits your goals and your organization. In a lot of cases, it will help you to tick some checkboxes: do you want to allow loans – yes or no? Is there a match? What kind? Which vesting schedule do you want to use? The plan document is more or less a boilerplate required language for any plan, but the adoption agreement makes it your own plan.

The trust is a legal entity, and is sometimes called the plan. Using a plan document and adoption agreement often create the trust for you. Due to the fact that all trust need to have a trustee, you will have to decide who will serve as a trustee for your plan. In most cases, it is the business owner, president, or somebody in a similar role. If you are your own boss, you will most likely serve as the trustee of your 401k plan.

It is the legal responsibility of the trustee to ensure that the plan follows all the rules and law, in order words, the position comes with its own risks – especially if you run a large company. However, countless trustees around the country have served for years without problem.

Plan administrator: the plan administrator is the person that administers the plan on a day-to-day basis. This position comes with a different responsibility from that of a trustee, but they need to be aware of important rules and guidelines. In a lot of cases, one person usually takes the mantle of the administrator and trustee.

Third party administrators (TPAs) are not the same as the normal administer. A TPA performs additional services for a 401k plan, such as filing tax returns for the plan, interpreting rules if there are any questions, discrimination testing, and processing loan or distribution requests.

A good TPA helps employers avoid making mistakes, and these organizations are available locally and nationwide. You might use a TPA as part of a bundled service with your record keeper or other vendors, or you can hire a firm that only does administration. When you want to customize a plan, specialized TPAs can be handy.

Record keepers or investment providers are the 401k vendors. They are the large financial companies that you send the contributions to. They print your statements and run the website where you can trade and invest. Depending on how you set up your plan, the investment provider and record keeper (as well as the TPA) might be the same company. This is often the arrangement for self-employed people setting up a Solo 401k.

Financial advisors and consultants are individuals or firms that provide advice to employers and employees. They also help to set up the plan, decide which investments to offer as part of a menu (if applicable), and which individual investments to choose within the plan for a fee. That said, TPAs and record keepers also provide some level of consulting, and they may be able to tell you everything you need as part of their standard services.

The setting up process

Now that we have familiarized ourselves with the terms you will encounter, you’re ready to set up a plan as an employer or self-employed individual. The basic framework for your approach might be:

  • Decide whether or not to use a financial advisor or other consultants
  • Decide which plan provisions you want
  • Choose a vendor (evaluate flat-rate pricing, investment costs and fees, and other features)
  • Complete the adoption agreement
  • Communicate and educate: inform employees (if any) of the plan’s existence and features
  • Set up individual participant accounts
  • Fund the plan
  • Review the plan regularly to ensure that it’s meeting the needs of plan participants
  • Adjust the plan as regulations change and your needs evolve
Ajaero Tony Martins