How to prepare for retirement by establishing a small business 401(k)

Most people realize that, in the 21st century, we all have to accept more responsibility for saving for our own retirement. One report from the Stanford Center on Longevity found that only half of Americans have access to work-based retirement plans, like 401(k)s, at their current jobs.

Leaving your money in a checking account — or as cash underneath your mattress — could leave you missing out on significant retirement savings. And, what about your employees? They’re going to need nest eggs, too. Providing investment options to your employees could prove beneficial for all parties.

If you’ve never had to select a small business retirement plan, you may be wondering where to start. Consider this article your complete guide. We’ll cover what small business 401(k)s are and why you need to consider them for your business.

We’ll then cover some of the things to look for when establishing one of these retirement accounts. By the end of this article, you’ll have a much more robust understanding of the 401(k) investment choices available to small companies.

What is a 401(k)?

A 401(k) is an employer-sponsored retirement savings plan offered by many employers to their employees. Typically, employees can fund their 401(k) plans through automatic payroll withholding. Employers can opt to make matching contributions up to a certain percentage.

For instance, an employer may offer to match dollar for dollar up to 4%. So, let’s say that an employee elects to fund their account with 10% of his or her pre-tax income. The employee earns $60,000 per year. So, the annual employee contribution is $6,000.

The employer matches up to 4%. In this case, the employer provides $2,400 of funding at no cost to the employee. At the end of the year, the employee’s 401(k) will reflect $8,400 in deposits, even though they only funded $6,000 of that.

The employer can decide whether they’d like to match and, if so, how much. If you’re a cash-strapped business, you can elect to provide a 401(k) option without matching now and offer fund matching at a later date. Matching is also a tool that you can use to recruit employees. Just know that it’s an option, but it’s not required to start your small business 401(k) program.

Furthermore, not only do 401(k)s act as a form of retirement planning, they can also act as a form of tax relief. Employees can generally elect to fund traditionally or as a Roth. Under traditional funding, the employee makes pre-tax contributions. The contributions lower the individual’s taxable income.

While beneficial in the short-term, employees will have to pay taxes on the money when they make a withdrawal. If the employee is in a low tax bracket now than they will be at retirement, it could cost them in the long run.

If an employee elects to make Roth contributions, the contributions are made post-tax. Then, the only thing you have to pay money on is interest earnings. If you expect to be in a higher tax bracket later in life, then you may want to consider the tax benefits that a Roth 401(k) offers. However, most people will be in a lower income bracket after retirement since they will not hold a job.

The final important thing to consider is what’s known as “vesting.” Vesting is when employees will have ownership over their entire 401(k) plan — both the amount that they have contributed and the funds that your business has matched. If the employee is 100% vested, they own complete control over the funds in the 401(k), including what the employer contributed. Employees always own the contributions they’ve made but don’t own employer contributions until the 401(k) is 100% vested.

If the percentage is anything less than 100%, then the employer holds a portion of the fund. Typically, the longer an employee is at a company, the more vested he or she becomes. For instance, imagine an employee who is 50% vested and has contributed $10,000 while the company has matched $2,000. The employee leaves. The employee can roll over the $10,000 principal he or she contributed along with $1,000 of the employer contributions (or the 50% that was vested).

Why consider a 401(k) for small business?

As a small business owner, you may be looking at a 401(k) and thinking that it’s not very cost-effective. However, the costs associated with a 401(k) could be worth it. Here are six practical reasons your small businesses should consider offering a 401(k) plan.

1. 401(k) plans are great for recruiting

In the past, employees were guaranteed at least a certain amount of income through pension plans offered by employers. These days, pension plans are becoming rare, and employees realize the benefits of joining a company that offers a 401(k) plan.

If an employee has the choice between two equally-appealing job offers and one company offers a 401(k) plan, it’s likely to sway their decision. In other words, 401(k) plans are a must-have benefit that will help attract top talent to your small business. They can make up a significant portion of the benefit plan you offer eligible employees.

2. 401(k) plans help reduce employee turnover

Small-business employees say they would leave their current job for one that provides a 401(k), and retirement plans are among the top 10 reasons why employees choose their employer.

Offering a 401(k) plan not only shows that you care about your employees, but also helps you be more competitive in the marketplace. Retaining employees means you’ll spend less money on recruiting and training new ones.

This may mainly be the case if you elect to vest your 401(k) offering. If plans only become vested over time for plan participants, you end up incentivizing them to stay.

3. 401(k) plans help you save on small-business taxes

Your business might be eligible for a special $500 tax credit for the first three years of your 401(k) plan. If the $500 tax credit for starting up a 401(k) plan isn’t convincing enough, then the tax deductions for employer contributions should be. As a bonus, by investing in your own plan, you can save on your personal taxes, too.

4. 401(k) plans are simple to set up and maintain

Today’s web-based small-business 401(k) programs are designed to be easy for the plan administrator to set up, administer, and maintain. With online setup and management, plan administration requires a minimal time commitment and little to no paperwork. Employees have 24/7 access to their online 401(k) accounts, and a retirement specialist is just a phone call away.

5. 401(k) plans help small-business owners support their own retirement

Too many small-business owners focus solely on the success of their business while shortchanging their own personal retirement security. A 401(k) plan makes sense regardless of how long you’ve been in business. Even if you decide to start another company, you can simply roll over your 401(k) balance to a new account.

If you don’t take the time to set up a 401(k), then you’re going to need to look at either an SEP IRA or a SIMPLE IRA. SIMPLE IRAs act very similar to 401(k)s in that employees can make contributions to them. However, the contribution limits for a SIMPLE IRA are significantly lower than those for 401(k)s, which means employees won’t be able to put nearly as much money into the fund.

An SEP IRA could be another option, especially if you’re self-employed. SEP IRAs are low-cost alternatives to 401(k)s. However, only employers can make contributions to an SEP IRA.

6. 401(k) plans contribute to the economy

When small-business owners equip employees with the tools necessary to retire comfortably, they contribute to building a healthy economy — and a society of people with more disposable income. A strong economy benefits all small businesses because it makes people more capable of buying your goods or services.

Things to consider when choosing a small business 401(k)

If you’ve decided that a 401(k) is best for your small business, you may be curious about what to offer. Should you offer employees a traditional IRA or a Roth IRA? Will employees have access to exchange-traded funds (ETFs), mutual funds, or both? How concerned are you about low fees?

Many of these decisions will take care of themselves, depending on the plan type you choose. Brokerages like Vanguard and Charles Schwab, among others, will offer plan designs that allow you to choose from various criteria. Below, you’ll find the three criteria we think are most valuable when selecting a 401(k).

1. Cost

Each 401(k) will have fees of some sort. Some of these fees fall on the employer while others fall on the employee. Just remember that costs can add up quickly and cut into your earnings over time. We recommend paying particular attention to low-cost 401(k) options to incentivize both yourself and your employees to enroll in the program.

2. Ease-of-use

Because a 401(k) is a retirement vehicle, it’s not something that should require an active trading strategy. Instead, it should be something that employees can put their money into and forget about, only checking in on it from time to time.

Similarly, as the employer, you don’t have a lot of time to be running a 401(k). You have other things to worry about, such as purchasing retail space and raising funds to grow your business. Running a 401(k) is complicated. It takes a lot of work to run the fund successfully, remain compliant with government regulations, and avoid audits

Try to work with a brokerage who will handle most of the administrative work for you. Additionally, see if the brokerage will work with your trusted accounting software so automatic withdrawals are sent directly to the management company.

Look for firms that are 3(16) and 3(38) fiduciaries. This means that they take legal responsibility for the administration of the plan. You’ll protect your firm by electing one of these fiduciaries.

3. Flexibility

First and foremost, you’ll want to make sure employees have enough investment options to choose from. The options should allow them to meet their desired portfolio and retirement goals. Offering a broad lineup of several low-cost index funds should be the bare minimum.

Similarly, make sure you offer a few different plan design options. Meaning, the employee should be able to choose between things like traditional 401(k)s and safe harbor 401(k)s, which allow employees to avoid specific compliance tests. Furthermore, you’ll need to consider things like when the plan will vest and how much you’re willing to fund into your employees’ accounts.

Is a small business 401(k) right for you?

As a small business owner, you not only need to be concerned with the present, but with the future, as well. One of the ways you can plan for the future is by opening a small business 401(k). Not only will this retirement plan set you up for future success, but it will also help your employees as well. Be sure to talk with a trusted brokerage to learn more about the options available.