A 401(k) allows high levels of employee pre-tax saving with the option for employers to make contributions, all professionally managed and administered.
“Do you have a retirement program?” It’s one of the most basic questions that prospective employees ask their future boss. The 401(k) has morphed from a fringe benefit to a “name brand” retirement plan. If it’s not being offered, your employees know it, your new talent is certainly looking for it, and it can be one of the most important aspects of your own compensation package.
So if your company does not offer some kind of basic retirement program, you’re likely missing out on great talent who are choosing other firms.
Setting up a 401(k) for the first time may seem daunting, but implementation can be very flexible based on your company’s needs. Many are surprised to learn that there are relatively low-cost options to starting a plan. If you’re on the fence about creating a 401(k), read below to see the pros and cons of creating one.
Why a 401(k)? Encourage employee saving + option to incentivize/reward
A 401(k) allows employees to defer a portion of their salary pre-tax to put towards retirement. Employers have an option to match any contributions or make separate additions, known as profit-sharing contributions. Matching is not a requirement, as employers can choose different matching or profit sharing guidelines when setting up a plan.
A 401(k) allows you and your employees to save for retirement with income before it is taxed. Those who contribute to a 401(k) benefit from a lower tax bill and potentially far greater savings growth into the future. Employees can contribute up to $18,500 a year (or $24,500 if they are 50 or older) from their salary.
Businesses can also make profit sharing contributions into a 401(k) as a way to incentivize performance or reward behavior. Profit sharing contributions can be up to a maximum of 100% of the employee’s salary or $55,000, whichever is less. Businesses can deduct any 401(k) contributions; unlike cash bonuses, profit sharing contributions are not subject to payroll tax.
Costs and administration requirements
Because of the significant tax-saving benefits of 401(k)s, plans need to follow strict IRS guidelines and undergo annual compliance testing. A 401(k) plan is therefore professionally managed and administered. This is where higher costs and administration efforts come into play.
The parties involved in running a 401(k) plan are the Third-Party Administrator (TPA) (plan set up and annual reporting), Recordkeeper (administration of employee accounts), and Investment Advisor (monitors menu of investment options and consults with owner on plan set up and vendor selection). There is a cost to each of these services, which can be paid by the employer as a business deductible expense, or allocated among employees and charged to their accounts. Costs can vary greatly based on plan features, the provider, investment choices, number of employees, and overall assets in the plan. The average total cost for a plan with between $1 million and $10 million in assets was 1.60% of plan assets in 2012, according to the Investment Company Institute report, A Close Look at 401(k) Plans. Yet for start-up plans or plans with a low level of assets, the fee can be just a few hundred dollars per employee. The IRS also offers a $500 tax credit for plan start-up costs during the first three years
One of the main reasons that employers struggle with 401(k)s is the required nondiscrimination testing. This required testing ensures that the “rank and file” participants are being treated equally to highly-compensated employees. Simply put: the little dogs control the big dogs. If less-compensated employees are not putting much into the plan, this will limit what owners and highly-compensated employees can invest for themselves. Your plan’s TPA will test annually to determine if the plan meets the required guidelines and suggest possible strategies to increase owner contributions, such as establishing a Safe-Harbor 401(k).
Flexible design to meet employer needs
Businesses owners have flexibility when establishing a plan. In addition to setting matching or profit sharing levels, plans can have different eligibility requirements or vesting levels. So for those worried about employee retention can offer a vesting schedule that requires employees to work for several years before employer contributions becoming fully vested.
Businesses starting out can offer a 401(k) without matching and then gradually increase their matching options as a future incentive as the company continues to grow. Even if your business is not ready to make significant employee contributions, a 401(k) is a valuable benefit to offer. The administrative costs and effort are greater than employee-managed plans, such as a SEP IRA or Simple IRA, but the costs can be offset by your ability to attract better employees, strengthen company culture, or maximize your own retirement savings.
Establishing a 401(k) plan is a long term commitment to your business and your employees. Planning, building and managing a 401(k) plan involves multiple choices that can directly impact your employees’ financial security and satisfaction with their job.
QUICK FACTS – 401(K)
- Employees can contribute up to $18,500 of their salary, tax deferred
- Employers have an option to match employee contributions, or make additional profit-sharing elections, up to $55,000
- Plan and investments are professionally managed and administered
- Annual testing and administration costs can be paid as a business deductible expense or allocated among employee accounts
- Flexible vesting and eligibility rules
- Employer may claim $500 tax credit for plan start-up costs in first three years
Windgate does not provide tax advice. Consult your professional tax advisor for questions concerning your personal tax or financial situation.
Data here is obtained from what are considered reliable sources as of 6/30/2017; however, its accuracy, completeness, or reliability cannot be guaranteed.