As the labor pool becomes a bit tighter, small business owners look for time-tested ways to recruit and keep workers. For example, 401(k) plans are a valuable option for businesses considering a retirement plan, providing benefits to employees and their employers.
Employers start a 401(k) plan for many reasons, including the fact that it allows participants to decide how much to contribute to their accounts. Employers are entitled to a tax deduction for contributions to employees’ accounts.
The money contributed may grow through investments in stocks, bonds, mutual funds, money market funds, savings accounts, and other investment vehicles.
Contributions and earnings generally are not taxed by the federal government or by most state governments until they are distributed. Further, a 401(k) plan may allow participants to take their benefits with them when they leave the company, easing administrative responsibilities.
Establishing a 401(k) Plan
When you establish a 401(k) plan, you must take certain basic actions. One of your first decisions will be whether to set up the plan yourself or to consult a professional or financial institution – such as a bank, mutual fund provider, or insurance company – to help with establishing and maintaining the plan.
In addition, there are four initial steps for setting up a 401(k) plan:
1) Adopt a written plan document.
2) Arrange a trust for the plan’s assets.
3) Develop a recordkeeping system.
4) Provide plan information to employees eligible to participate.
Plans begin with a written document that serves as the foundation for day-to-day plan operations. If you have hired someone to help with your plan, that person likely will provide the document. If not, consider obtaining assistance from a financial institution or retirement plan professional. In either case, you will be bound by the terms of the plan document.
Once you have decided on a 401(k) plan, you will need to choose the type of 401(k) plan that is best for you – a traditional 401(k) plan, a safe harbor 401(k) plan, or an automatic enrollment 401(k) plan. In all of these plans, participants can make contributions through salary deductions.
A traditional 401(k) plan offers the maximum flexibility among the three types of plans. Employers have discretion over whether to make contributions for all participants, to match employees’ deferrals, to do both, or to do neither. These contributions can be subject to a vesting schedule (which provides that an employee’s right to employer contributions becomes non-forfeitable only after a period of time). Annual testing ensures that benefits for rank-and-file employees are proportional to benefits for owners/managers.
There are several kinds of 401(k) plans that aren't subject to the annual contributions testing required with traditional 401(k) plans. These are known as safe harbor 401(k) plans and, in exchange for avoiding the annual testing, employees in these plans must receive a certain level of employer contributions. Under the most popular safe harbor 401(k) plan, mandatory employer contributions must be fully vested when made.
An automatic enrollment 401(k) plan allows you to automatically enroll employees and place deductions from their salaries in certain default investments, unless the employee elects otherwise. This is an effective way for many employers to increase participation in their 401(k) plans.
The traditional, safe harbor, and automatic enrollment plans are for employers of any size.
SOURCE: US DEPARTMENT OF LABOR
