Thinking about setting up a 401(k)? It's reportedly the most popular employer-sponsored retirement plan among small businesses for several reasons: It helps attract and retain employees, it provides tax deductions to employers, and it helps employees fund their retirement. But is it the wisest choice for you?
The 401(k), in which participation by employees is optional, allows you and your employees to shelter income from taxes. If you elect to contribute matching funds to your employees' contributions, however, it will impact your bottom line, now and in the future. Consider carefully whether you'll be able to meet that ongoing financial obligation.
You'll also need to decide if employees should direct investments of their accounts, be given limited investment alternatives or have investment decisions handled by the plan administrator. Employees might prefer a broad range of investment options, but that increases the complexity (read: cost) of plan administration.
Here's the fine print: Your plan must be in writing, be explained to all employees and exist for the exclusive benefit of beneficiaries; it may not favor highly compensated employees; it must entitle employees to all their contributions and, once vested, ensure employer-matching contributions; and it must make sure employees are completely vested after five years of service.
Phillip Cook, a certified financial planner in Torrance, California, says he wouldn't consider a 401(k) plan for a company with fewer than 25 employees. "For one thing, it's too expensive," Cook says. "It will cost a minimum of $500 to $1,000 annually just to administer the plan. That's a lot if you just have a handful of employees."
In addition, Cook warns, "Administration and filing of reports [with the IRS, the Department of Labor, the Pension Benefit Guaranty Corporation and all plan participants and beneficiaries] is cumbersome and time consuming."
The certified financial planner says an entrepreneur "can contribute the same amounts and get the same tax deductions with plans that cost as little as $50 a year." He recommends a SEP-IRA, a traditional profit-sharing plan, a money purchase pension plan or a SIMPLE IRA, all of which are less expensive to administer.
Setting up a retirement plan represents a commitment that will affect your business for a long time. Before making decisions, get assistance from financial and legal professionals. To find a financial planner, contact the Institute of Certified Financial Planners (800-282-PLAN, http://www.icfp.org); for a brochure on IRA choices, call ReliaStar (888-757-5757).