Small business owners have more choices than ever when it comes to buying a 401(k) retirement savings plan. From a traditional plan with higher costs but more flexibility to newer, automated and streamlined plans sold by a handful of financial technology companies there is likely a plan to match your small business needs and pocketbook.
To determine which plan type and plan provider best fits your business, consider your budget and your workforce. How many people will the plan have to cover? Can you afford to match your employees’ contributions? Some plans require that you do. How much money will your plan have to manage? Will you or your employees want a lot of investment choices or a minimal menu?
To get started, here is an overview of the five types of 401(k) plans from which a small business can choose. Except for the Solo 401(k), the plans are designed for a business with at least one employee, not counting the business owner.
Traditional: This type of 401(k) plan gives your small business the most flexibility. With this plan, you can decide whether or not to make contributions to employees’ 401(k) accounts. If you do, you can choose whether to match all or part of an employee’s contributions. You also can decide to make separate, non-match contributions that go to all employees eligible to participate in the plan, whether or not they do. And you can change your decisions and contribution levels each year as business conditions change. Also, under a traditional 401(k), the time it takes for your employer contributions to vest — or fully belong to the employee — can take longer than with other plan types, up to five years.
But a traditional 401(k) plan can be more expensive and complex to administer for you and your plan provider in part because it has to meet IRS fairness tests that require annual filings and reports to several federal agencies. The IRS allows employers to deduct their contributions to employee accounts, up to certain limits. In exchange, the plan has to prove it is fair: It isn’t set up to benefit the owner or managers more than rank-and-file employees.
Safe Harbor: This type of plan is automatically in compliance with IRS fairness rules. That saves you time and paperwork. But it requires that you as the small business owner contribute at least a minimum amount to your employees’ retirement accounts each year. You can either do an employee match, where you match each dollar contributed by individual employees that participate in the plan, up to 3% of their salary. (You can make an additional match of 50 cents for every dollar they put in, up to 5% of their salary.) Or you can contribute to a 401(k) account for each employee eligible for the plan, whether or not they contribute. Those contributions have to equal 3% of each person’s wages.
A Safe Harbor plan also requires that workers be immediately vested in employer contributions
SIMPLE: This plan is for small businesses with 100 or fewer employees and no other retirement savings plans. It can be more cost-effective in part because it requires less paperwork (it automatically meets IRS tests for fairness). But as the employer you have to either make a matching contribution for all participants, up to 3% of their wages ,or you have to make a straight 2%-of-wages contribution to 401(k) accounts for all employees eligible to participate in the plan, even if they don’t. Employees are immediately fully vested in all contributions.
Automatic Enrollment: Under relatively new federal legislation, employees now can be automatically enrolled in your 401(k) plan. This can boost participation rates. Higher participation rates can help your 401(k) pass annual testing meant to ensure it doesn’t favor higher earners. This plan also allows you to set a uniform contribution rate for all employees and raise it each year, subject to certain limits, unless workers opt out or specifically choose a choose a different level. And there is a safe-harbor version, too, that requires you to match your employees’ contributions at a minimum level.
These plans can cost less because they save time on administration chores.
Solo/Individual: This plan is right for you if your small business has no employees or consists of just you and your spouse. Because there are no employees, a Solo 401(k) doesn’t have to perform annual nondiscrimination testing. It allows you to put away a lot of money towards retirement each year, up to
Once you decide what kind of plan best fits your small business, you can decide what service provider you want to work with. Although you can set up a plan yourself, the requirements can be onerous and you will have full fiduciary responsibility for it.
Traditionally, large financial services companies including Fidelity Investments, Charles Schwab Corp. and Vanguard Group Inc. as well as giant insurance companies like Principal Financial Services Inc. have dominated the 401(k) market for businesses. And while they offer plans geared to smaller businesses, the costs for employee participants has been higher, up to twice as high according to one government report, in part because they don’t bring a lot of investable money to the table.
If your small business has limited time and money to invest in a plan, an online provider can be a good bet. These companies, including Captain 401, often offer automatic enrollment plans that keep keep costs down by enrolling all employees and offering limited but low-cost investment options.
Whichever route you decide to take, get started now! Your small business will reap the rewards in attracting and keeping great employees and retirement will be that much easier for you and your team.