401(k): What Small Businesses Need to Know

When it comes to employee benefits, there are few perks workers desire more than 401(k) retirement plans. Recent research from Justworks revealed that nearly 40 percent of employees say access to a 401(k) plan is the benefit that matters most to them, only behind healthcare and paid time off.

A 401(k) plan is an employer-sponsored benefit that allows employees to save money for retirement. According to the IRS, a 401(k) is a feature of a qualified profit-sharing plan that allows employees to contribute a portion of their wages to individual accounts. Employees typically have several choices for the types of accounts the money is invested in.

Employees can sign up for these plans and designate a percentage of their paycheck to be automatically placed into a retirement investment account. There are two types of 401(k) plans. In a traditional 401(k) plan, the money employees choose to invest in the plan is pretax. This means that the money they contribute comes out of their paychecks before taxes are deducted. However, they will pay taxes on the money when they withdraw it.

The other option is a 401(k) Roth plan. With this option, the money comes out of the employees' paychecks after taxes have been deducted, and they won't pay taxes on the money when they withdraw it, since it was paid upfront.

Eliza Badeau, director of workplace thought leadership at Fidelity, said that in the current environment, most workers are responsible for the funding of their retirement.

"We are shifting from an employer-funded pension plan to a defined contribution plan landscape," she said. "A 401(k) is a great way to save for the future."

To boost participation, employers sometimes make matching contributions based on how much the employee is contributing. For example, an employer might match a contribution up to a certain percentage. So, if an employee contributes 4 percent of their paycheck, their employer might match that contribution. This essentially doubles the amount the employee saves.

While these plans are sponsored by the employer, the money being invested belongs to the employees. The money they contribute to their account is theirs to take if and when they move on to a new job. As for the employer contributions, there is often a vesting period that requires an employee to stay with the company for a certain length of time before they can take that money with them if they land another job.

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While this is a benefit traditionally offered by larger organizations, Badeau believes small businesses should strongly consider offering it. 

"Many [retirement plan] providers have solutions that are great for small businesses," she said. "Fidelity works with thousands of small businesses."

Badeau thinks this benefit can go a long way in attracting and retaining top employees. "I think it is really important, if you are trying to grow your business, to think through offering a 401(k) plan and what that can mean to attracting and keeping talented employees."

Employers that want to start offering 401(k) plans have several ways to get started. There are numerous financial institutions, like Fidelity, Charles Schwab and Merrill Edge, that they can partner with.

Another option is to work with a human resources services provider, like a payroll or PEO company. In addition to their core features, many of these HR providers offer 401(k) plan management.

Rick Chen, a spokesperson for payroll and HR services provider Gusto, said payroll companies can be good 401(k) partners.

"A payroll provider may be the best option, as they can process any necessary deductions automatically when payroll is run and eliminate duplicate data entry," he said.

As to whether or not to offer a retirement plan to employees, some small businesses might not have a choice, depending on the state they operate in.

"Many states have passed laws which require employers to provide employer-sponsored retirement programs," Chen said. "For example, California requires businesses with five or more employees to offer a retirement plan or provide access to a Secure Choice IRA through the state-run fund."

He encourages small business owners and entrepreneurs to research whether their state has any similar requirements and at what point they might take effect.

Once you've decided which plan provider to partner with, there are some other choices you have to make, including how many different choices employees will have for the funds they invest in and what types of funds those are.

"There are a lot of different features and functions," Badeau said. "It all depends on [how] you want the final plan to look."

One option is an automatic enrollment policy. With this, each employee is automatically enrolled in the plan at a certain savings percentage unless they specifically opt out.

The biggest factor to consider is whether to offer matching contributions. While nothing requires employers to offer this added benefit, Badeau thinks it could pay off in the long run. "A well-designed 401(k) plan, with a company match and that incentive, can really help keep people and attract the right people they are looking for."

Among the small business 401(k) plans Fidelity manages, Badeau said, 85 percent offer a matching contribution, with the average match being 4 percent.

In addition to paying off for the employer, matching contributions are a significant positive for employees. Badeau said they help incentivize employees to save more. "It is likely they will contribute enough to reach that max, so it encourages them to have a higher contribution rate."

While matching contributions can be a positive for employers and employees, there are some instances when it might not make sense to offer them.

"If a company is not yet profitable or is going through a tight financial situation, for example, they may not want to match contributions," Chen said.

Another added feature is a professional managed option. With this option, employees essentially have access to a financial advisor who will help them make the best decisions for contribution amounts and fund options. 

For small businesses, there are costs for offering a 401(k) retirement plan, which can vary greatly.

Chen said there are typically setup and maintenance fees, the latter often based on the number of participating employees. He said small businesses can offer 401(k) retirement plans to their employees for as little as $40 per month and a one-time $500 setup fee through Gusto, for example.

It is essential to note, however, that added features such as automatic enrollment, increased fund options or professionally managed services will probably increase a company's costs.

"It is important for employers to be conscious of those when considering [whether to offer a 401(k) plan]," Badeau said.

Some of the costs can be offset by certain tax deductions that small businesses with fewer than 100 employees may be eligible for.

"Some administrative fees are considered tax-deductible business expenses," Chen said. "Small businesses may be eligible for the Credit for Small Employer Pension Plan Startup Costs, a tax credit of up to a maximum of $500 per year, which covers 50 percent of eligible setup costs to qualified retirement plans."

If your small business doesn't feel comfortable offering a 401(k) plan, you have some other options for giving your employees a way to save for retirement.

"While it is the most well-known, there are other employer-sponsored retirement plans besides the 401(k)," Chen said. "Small businesses that employ 100 or fewer people can provide SEP-IRA programs, for small business owners or the self-employed, and SIMPLE-IRA programs, which, as the name suggests, is designed to be a simple alternative to 401(k) retirement plans, for example."

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