You don’t have to be a large, profitable business with an equally large staff to start a 401(k). Recent changes in federal tax laws made sure of that, and there are now plans to cover the span of business models, from the owner-only startup to the global enterprise.
Do I need a 401(k) plan for my business?
A survey by Boston-based Fidelity Investments, one of the world’s largest providers of financial services, indicated that one out of four small business owners believe there isn’t a 401(k) plan to suit their company’s needs.
“This is a case where perception is not reality, because small businesses of any size can get a 401(k) plan today that’s cost-effective and easy to implement and administer,” says Edmund F. Murphy, executive vice president, Fidelity Institutional Retirement Services Company.
With the burden of retirement savings now falling on the employee, financial planners agree that the sooner you get started, the better. And with the Pension Protection Act of 2006 passed by Congress in summer 2006, there are benefits for small business owners to offer a 401(k).
How do I get started?
Most financial advisors say the sooner you start saving for retirement, the better. Len Ligotti, sales development manager for Chicago-based LaSalle Financial Services, says the same logic applies to a 401(k) plan. “For many individuals without pensions, it provides a means of self coverage, sheltering savings on a pretax basis and putting away a larger amount than with an IRA product.”
To start a 401(k), you need to do the following:
- Create an official document to establish the guidelines.
- Determine who will be covered based on age, length of service and employee status such as full- or part-time.
- Know the legal minimum guidelines. These are outlined on several websites, including the IRS and U.S. Department of Labor’s (DOL) Employee Benefits Security Administration.
- Decide what type you want.
Types of plans, as outlined by the U.S. Department of Labor, include:
- Traditional -- Offers the maximum flexibility of the three plans. Employers can make contributions on behalf of all participants, to match employees’ deferrals, or do both. These can be subject to a vesting schedule.
- Safe Harbor -- similar to a traditional plan but must provide for employer contributions that are fully vested when made. There are fewer tax rules with this plan.
- SIMPLE plan – The Savings Incentive Match Plan for Employees of Small Employers was created so small businesses could have an effective cost-efficient way to offer employee retirement benefits. This is available to employers with less than 100 employees. Employee contributions are fully vested.
Daniel Lamaute of Virginia-based Lamaute Capital, Inc., says the best time to start your plan is before the end of the year, since you’ll still get the full year’s deduction. He says it’s particularly important for owner-only businesses to look into a 401(k) plan.
“There are over 18 million owner-only businesses and 50 percent of owners are between 45-64 years old,” Lamaute says, citing census statistics. “These are important retirement saving years.”
Until 2001, the laws didn’t make it effective for the self-employed to have a 401(k) option, but the Tax Relief Act changed that. Now, owner-only businesses decide how much to contribute and, compared to other retirement plans, the 401(k) also allows you to contribute more. There’s the convenience of including a traditional IRA into your self-employed plan, and the loan option can be helpful.
“We’ve found that the most popular feature is the loan option because of the flexibility to borrow up to $50,000,” Lamaute says.
When businesses flourish and more staff is hired, the self-employed 401(k) must be converted to another plan, unless the employees are also owners or a spouse. “I tell clients to look two years down the road. That way, we can establish the plan they will need and keep them from jumping around,” Lamaute says.
401(k) advantages: a list
Employers start a 401(k) for many reasons including:
- Better employee retention.
- All employer contributions are deductible on his or her federal income tax return.
- Deferrals and investment gains aren’t taxed until distribution.
“Many companies avoid starting a 401(k) plan because they feel it’s expensive,” Ligotti says. “However, when you investigate the expenses, you can find there are some that can be had for very little cost.”
Alice Rhein is a freelance writer for StartupNation.