It's National 401(k) Day. Here's How to Choose the Right One for Your Employees A five-step process you can use for your business.
By Kevin Busque Edited by Dan Bova
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Did you know that National 401(k) Day is September 8? For small-business owners, it's hard to think of a better time to evaluate the options for providing this powerful benefit to your employees. Research indicates that half of American families have no retirement savings, and less than half of small businesses offer a retirement plan, so time is of the essence.
Offering a 401(k) sends a clear message to your employees that you care about -- and are willing to literally invest in -- their future. Nearly six in 10 workers who are extremely satisfied with their benefits are also extremely satisfied with their jobs. Coincidence? Probably not.
But, getting started is complicated. There are lots of options, and very few of them are easy to understand. Many programs today are laden with complicated fees that prohibit participants from understanding where their money is going, and who's really benefitting from their investment.
As you can imagine, building Guideline -- a 401(k) platform -- put me through a 401(k) information boot camp. In this post, I hope to provide small-business owners with the information they need to get started by outlining the first five steps you'll need to take.
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Establishing a 401(k)
For businesses that are ready to take the plunge, the IRS website covers the actions you need to take to get everything set up. In the event you don't speak in tax code, here's a more approachable look at what goes into setting up a 401(k) retirement plan:
1. Plan type
When choosing a plan type, the biggest consideration is how you want to prepare for annual nondiscrimination testing that's designed to make sure plans are accessible to employees of all compensation levels, be it entry or executive level. Plans that require employers to make contributions to employees' 401(k) accounts will tend to have an easier time passing the tests, and may even be exempt from testing if they're designed properly. A plan that doesn't require employer contributions will cost your company less, but be at risk of plan failure.
Here are the three plan types, along with their pros and cons:
- Traditional 401(k). Employers can choose between not contributing, making outright contributions or matching a portion of the wages employees defer. An employer can also set up contributions that are subject to a vesting period. While all this flexibility is useful, a traditional plan must pass nondiscrimination testing each year.
- Safe Harbor 401(k). This plan type is similar to the Taditional plan, but it requires employers to make contributions above and beyond what their participants choose to defer. These contributions you offer must be of a certain size (at least 3 percent of an employee's taxable wages), and they must vest immediately. By committing to making these contributions, a plan gets to bypass nondiscrimination testing. Companies of any size can offer a Safe Harbor plan.
- SIMPLE. SIMPLE is actually an acronym for Savings Incentive Match Plan for Employees. This plan type is specifically for businesses with fewer than 100 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.
There are very specific rules about how contributions are structured in these plans. It's all spelled out in our Safe Harbor 401(k) guide if you want to learn more.
2. Written plan
Once you've selected a plan type, you need to adopt a written document that -- according to the IRS -- "serves as the foundation for day-to-day plan operations." That language may sound a little intimidating, but your 401(k) plan administrator will usually handle this paperwork for you.
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3. Trust fund
A plan's assets must be held in trust to assure that they're used solely to benefit plan participants and their beneficiaries. In other words, all those employee and employer contributions need to be kept in a safe place and monitored by a designated trustee. This trustee is responsible for collecting the contributions, investing them as directed by the participants and issuing distributions.
4. Record-keeping system
It's important to maintain a reliable accounting of the activity in your plan. This step helps you keep track of contributions, earnings and losses, plan investments, the expenses and the benefit distributions from participants' accounts. If you have a plan administrator, they will typically help you take care of recordkeeping. Doing a good job will make the preparation of the plan's annual reports and business tax returns easy.
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5. Plan information for participants
As a plan provider, you are required to notify all eligible employees and beneficiaries about the 401(k) plan, in addition to any updates to it. Most often, this is accomplished via a summary plan description that's circulated on a recurring basis, detailing information about your plan and its benefits along with other documents related to privacy and fee structures.
