Now more than ever, benefits packages offered by workplaces are one of, if not the most important factor by which employees seeking work will make a determination for their place of employment. With our country’s youth increasingly preferring an increase in benefits as opposed to base compensation rates, 401(k)s are one of the most popularly sought after retirement benefit options. With the predicted wavering reliability of the social security system in the future, and less and less American occupations being offered the benefit of defined-benefit pension plans, 401(k) plans are one of the most lucrative retirement savings options that when offered, can help to make small businesses an attractive place of employment for an increasingly competitive workforce, constantly seeking opportunities for growth and security.
As an employer-sponsored retirement plan, 401(k)s are a defined-contribution benefit plan that takes contributions from the employee and employer. When the account is set up, employees are able to determine the proportion of their income they’d like to contribute to their account, and the specified amount is automatically deducted from their paycheck and added to the account. In addition, employers are able to “match” up to a certain percentage of employee’s contributions to the account. Since this is essentially free money, it’s easy to understand why Traditional 401(k) plans, more specifically, are such an attractive benefit option.
Employees must wait until the age of 59.5 to withdraw money from the account in order to avoid an additional 10% tax penalty on the funds. Additionally, Roth 401(k) accounts must be opened for at least 5 years to avoid additional tax penalties when making withdrawals. Employees must also begin taking required minimum distributions at the age of 70.5 to avoid significant taxation on savings in the account.
Current State of 401(k)s in the US
More than 58 million Americans are currently enrolled in 401(k) benefit plans. Despite their attractive nature, 401(k) plans can be relatively expensive and time-consuming to manage in relation to the number of administrative duties that are associated with their maintenance. For a long time, this has essentially rendered 401(k)s out of reach to small businesses without the employees, departments, or resources to hire outside parties to manage administrative tasks for them.
To this day, small and medium-sized businesses are as much as 11 times less likely to offer 401(k) plan options to their employees. While 92% of large businesses with more than 500 employees offer 401(k) plan options to their employees, only 12% of small business employees receive the same. Luckily, there are a number of alternatives to traditional 401(k)s that are a bit more accessible to small businesses, and still just as attractive as a benefit option, and a great resource for retirement savings for your company’s employees.
Account Type Options For Small Businesses
401(k) Profit-Sharing Plans
While traditional 401(k)s require employers to consistently contribute an agreed-upon rate to employee accounts up to a certain percentage of the employee’s contributions, profit-sharing plans offer a bit more flexibility. Contributions are made to employee accounts on basis of company profits by the employer alone. Thus, the employer ultimately makes the decision of how much, if at all, they should be contributing to employee accounts on a yearly basis. For smaller businesses, this may be advantageous because it allows the business to choose how much they’d like to contribute since contributions can become quite expensive with more than just a few employees (or even with just a few employees).
Businesses set aside a portion of their pre-tax profits to contribute to their employee retirement accounts. The money that is set aside is then contributed to the employee accounts based on a percentage of the employee’s salary, or a set dollar amount. Contribution limits toward these accounts are $58,000 a year or 100% of the employee’s salary, whichever is lower.
401(k) Profit-Sharing Plans come in 3 main formats that differ depending on how the money is distributed and contributed to the employee retirement accounts. Pro-Rata plans involved employers making contributions to employee accounts all at the same rate, a specified percentage of employee compensation across the board. This format is the most common profit-sharing plan option. Next, New Comparability plans work best for company owners who’d like to see higher contributions to their account than other employees. This plan allows you to group employees and make different contribution amounts to each group. Finally, age-weighted plans involve making contributions to employee accounts on the basis of how long the employee has been working, and how close they are to retirement: the longer the employee has worked, the more they will receive. This is a great option for individuals looking to retain employees for a longer period of time.
Simple 401(k) accounts are a little more stringent as to the requirements of how much employers must contribute to the account as compared to profit-sharing plan options. Simple 401(k)s, in addition to any employee contributions, require employers to either contribute a dollar-for-dollar match of up to 3% of an employee’s compensation, or a non-elective contribution up to 2% of an employee’s annual pay. Employees are limited in their contribution of up to $13,500 per year, with additional “catch up” contributions that are allowed to be made for individuals over the age of 50.
Not all businesses have a large number of employees. In fact, some businesses may not have any employees at all. Solo 401(k) accounts are a great option for individuals who are self-employed or otherwise the only employee in their business with the exception of a spouse. These accounts allow individuals to make the highest contribution amount to their retirement account as possible. The contribution limit for solo accounts is the lesser of 100% of your compensation or up to $19,500 on a yearly basis for individuals under the age of 50, and $26,000 for individuals over the age of 50. On top of this amount, the business itself is able to make contributions to your account in the amount of up to 25% of your total annual compensation. Participation in a Solo 401(k) does not bar you from participating in other forms of retirement accounts such as IRAs.
Traditional and Roth 401(k)s
While they can be more expensive, some small businesses still choose to utilize Traditional or Roth accounts, thus, it will be important for us to briefly cover. These operate as functional 401(k) accounts as was described in the 401(k) overview section. Employees choose a rate at which they’d like to match employee contribution to the account, up to a certain percentage of the employee’s compensation. The ability for employees to make contributions in addition to employer contributions is one of the largest distinguishing factors of these types of accounts from profit sharing 401(k) accounts.
Businesses may choose to offer traditional accounts, Roth accounts, or both which the employees will then have the option to choose from. The main distinguishing difference between the two accounts is that Roth accounts are taxed when the money enters the account, while traditional accounts are taxed when the money is distributed in retirement. What you choose to offer your employees should be based on the age of your employees and how close they are to the point of retirement. When employees are in the high-income earning years of their career, their tax bracket will likely be lower when they enter retirement, and Traditional accounts will likely be the better option for them. On the other hand, those that are early in their careers will likely see a higher tax bracket in retirement than they are in currently, so Roth accounts are likely the best option for them.
One of the most recent developments in the 401(k) space is the Modern 401(k), which is characterized by a number of features including streamlined administration through automation, robo-advising for employees, as well as a number of other services for onboarding employees and keeping plan participants educated. Since less of the process is run by an actual human being, prices for Modern 401(k)s are normally quite limited since there is no need to pay a robot. What’s more, is that these processes are extremely accurate when completed by AI (factoring out considerations of human error), and allows employees to access information and make changes to their 401(k) plan on a more frequent basis than other 401(k) plan offerings might allow.
Options For Keeping Costs Low
One way to keep retirement plan options low for small businesses is to entertain options other than popular Traditional and Roth 401(k) account offerings. However, even after this choice is made, there are a number of other options that businesses can consider to keep costs low. This allows companies to affordably offer competitive compensation packages whilst not breaking the bank.
Employer contribution matches can be a great way to attract potential talent to your company, and can additionally be a good way to encourage employees to make contributions to their accounts. While these accounts can be expensive to maintain, and contributions could be a large financial burden for your business, a framework for vesting periods can be put in place to ensure that contributions are going toward worthwhile employees who will drive value for your company for many years to come.
Vesting schedules or periods simply mandate that employees must work a certain number of years before they are able to walk away from a position and still maintain the contributions you as an employer have made to their account. When or if they do walk before the vesting period is over, contributions will be returned to you in part or whole. Normally, vesting schedules dictate that a certain percentage of your contributions are officially vested to the employee per year, such as 20% per year up to 5 years of employment, after which point your contributions will be fully vested to the employee.
Retirement Plan Management: In-House or Out-House
Depending on the size of your business, and how comfortable you are with spending valuable resources on hiring additional individuals to manage your retirement benefit plans, making the decision of whether to keep these duties within your company could be a good way to save money for your business. While you may not have the resources to hire an additional staff member to manage HR-related tasks and benefits administrative responsibilities, you may need to designate one of your current staff members as a recordkeeper for all things related to benefits which could divert their time from other responsibilities they hold within the company.
Some 3rd party plan administrators offer comprehensive benefits management, while other companies may take more of an al-a-carte approach that allows you to select which of the benefits-related services you’d like to pass along to them as opposed to handling yourself. Ultimately, the decision of whom you’d like to pass these tasks along to, and how much of these responsibilities you’d like to pass along will depend on your cost-benefit analysis of what will be worth spending your company time and resources on to drive value in the future. Be sure to take into account varying fees that are associated with different services, normally outlined in the fine print. Also, be aware that some plans may have increasing fee rates as you add more employees, which could make some service providers much more expensive in the future if you intend on expanding your company.
Choosing the Best Plan For Your Business
Benefits options are a wonderful way to attract and retain new talent in your company. There are many options to choose from and a lot of considerations to take into account. While these processes can seem overwhelming, financial advisors are a great point of contact for questions on which plan might be best for your small business. Advisors have comprehensive knowledge of different plan offerings, tax implications, and other policy implications that could make one plan offering a better fit for your business than another. Contact your advisor today, you don’t need to walk down the unknown path of choosing a 401(k) plan for your small business alone!