The small business guide to 401(k) retirement plans

Offering a 401(k) sends a great message to your employees. It says that you’re truly invested in their future with your company—and beyond. They can help employees save for retirement, while potentially providing your business with tax savings and a valuable recruiting and retention tool.

Studies show that half of American families have no retirement savings, and that less than half of small businesses offer a retirement plan. Given this unfortunate reality, it’s not surprising that offering a small business 401(k) can have a big impact on the way your employees think about your company.

How many employees do you need to have a 401(k) plan? Can small businesses even offer a 401(k)?

Let’s get this out of the way. Yes, any size business can offer a 401(k) plan. Traditionally, 401(k) providers charged small and mid-sized businesses exorbitant fees or ignored them altogether—leading millions of smaller businesses out in the cold without an easy way to offer meaningful retirement benefits. Guideline is changing that by offering small businesses an easy, affordable 401(k).

How do I set up a small business 401(k)?

If you’re ready to set up your small business 401(k), these are the four steps you’ll need to take.

For small businesses that are ready to help their employees save for retirement, the IRS website covers the actions you need to set up a 401(k) plan. In case you don’t speak in tax code, here’s a more approachable step-by-step guide.

Step 1: Choose a plan that meets your business goals

The big difference between 401(k) plan designs is how and when an employer makes contributions on behalf of its employees. Here are three types of plan designs, their requirements, and some other implications:

What other 401(k) plan features should I consider?

Offering retirement benefits is a great way to attract and retain talent. But specific plan features can really boost participation and make your small business 401(k) plan even more enticing.

Traditional vs. Roth 401(k). What’s the difference?

Generally speaking, the key difference between the two is when employee contributions are taxed. With traditional accounts, contributions are made before taxes are taken out of pay. Under Roth accounts, contributions are taxed first and then deposited. When an employee retires, withdrawals from traditional accounts are taxed at ordinary income rates, whereas Roth withdrawals can generally be made on a tax-free basis.¹ Read more about traditional vs Roth accounts.

Should I match employee contributions?

Matching contributions can be hugely beneficial for both employees and employers. For employees, they’re an additional form of compensation that can help maximize their retirement savings.

For employers, matching contributions may be tax deductible as an ordinary business expense, up to the annual corporate tax deduction limit on all employer contributions (25% of covered payroll).* Vesting schedules can help small business owners further customize their plan design to meet their business goals. Read more in our guide to 401(k) matching.

What is 401(k) profit sharing?

Profit sharing works like a bonus to an employee’s retirement account—with one big difference. Rather than be taxed immediately on that bonus, profit sharing contributions go straight into eligible employees’ retirement accounts without any tax taken at contribution. Employees won’t have to pay taxes on that money until they retire.* For employers, these deposits are income tax-deductible and also aren’t subject to Social Security or Medicare taxes—making profit sharing a win-win for both parties.

Step 2: Pick your dream team

Small business 401(k) plans can involve a lot of different service providers and advisors. When setting up your plan, you can choose to take an a la carte approach with several different providers. Or find one provider who can handle most, if not all, of the services required to set up and administer your plan.

When you offer a retirement plan through Guideline, we handle your recordkeeping, compliance testing, day-to-day plan administration, and more. That means your small business doesn’t have to sweat keeping track of disparate systems or vendors just to manage your 401(k) plan.

401(k) recordkeepers

No surprise: small business 401(k) plans require a lot of recordkeeping. Between all of the contributions, earnings, losses, plan investments, expenses, and benefit distributions, it’s a lot to keep track of. 401(k) recordkeepers are responsible for the following, to name a few:

Financial advisors and fiduciary responsibilities

In the context of retirement, there are generally two kinds of financial advisors that take on fiduciary responsibility: 3(21) and 3(38). These numbers refer to sections of the Employee Retirement Income Security Act (ERISA), the law dictating many of the rules surrounding retirement plans. Here’s how these “fiduciaries” differ:

A Section 3(21) advisor will do the heavy lifting in selecting and maintaining investments for your plan and hopefully provide you with advice to make better decisions on your own. That said, you’re still responsible for calling the shots. If you don’t consider yourself a retirement pro, this approach leaves you and your company on the hook for bad or risky decisions.

A Section 3(38) investment manager has full control over money management for your plan. That means they also take on liability for investment selection and sometimes asset management. Your duties are limited as a plan sponsor to prudently select and monitor a fiduciary. Therefore, opting for a 3(38) investment manager might be the best decision if you aren't well versed in how retirement plans work.

401(k) third party administrators

There’s a lot of behind-the-scenes work that needs to happen to keep your small business 401(k) plan in good standing. Though their responsibilities vary, 401(k) plan administrators generally handle:

While 401(k) plan administration can be handled in-house, many choose to outsource the function to a third party administrator (TPA). But not all TPAs are created equal. If yours is an ERISA 3(16) fiduciary, they won’t just handle administration but they will also take on liability for doing these things in accordance with ERISA regulations. Read more about 401(k) administrators.

What’s the difference between a trustee and a custodian?

By law, your 401(k) plan’s assets must be held in a trust account to ensure that they’re used solely to benefit plan participants and their beneficiaries. In other words, your employees' money needs to be kept in a safe place by a custodian and monitored by a trustee.

Keep in mind that custodians are the parties that actually hold your plan’s assets, while trustees are responsible for collecting contributions, investing them, and issuing distributions. These tasks can be delegated to a plan administrator, but the trustee will have ultimate responsibility to ensure the administrator is doing its job.

Payroll providers

Employees will contribute to their retirement accounts come payday. That means you’ll need to partner closely with your payroll provider to ensure employees’ personal information and retirement contributions are accurately reflected in all systems.

When employees update their contribution rates in your retirement vendor’s platform, for example, this should feed into the tool you use to run payroll. Choosing a 401(k) provider that fully integrates with your HR and payroll providers can save time and reduce errors.

Step 3: Make it official

Adopt a written plan

Once you’ve settled on your plan types and features, you need to create a written plan document that, according to the IRS, “serves as the foundation for day-to-day plan operations.” While that language sounds intimidating, it’s just referring to a description of the benefits, rights, and features under your plan. Your 401(k) plan administrator will usually handle this for you.

Your plan documents should include the following features, for example:

Getting this information right and making sure that it’s readily available is critical when you need to demonstrate compliance during an audit.

Onboard employees

For many plan designs, you’ll need to notify eligible employees about the 401(k) plan before it goes into effect—usually 30 days in advance. Moving forward, you’ll also need to give notice of any changes. A summary plan description serves as the primary way to share information about your plan and its benefits. If you include plan features like automatic enrollment, Safe Harbor, or a qualified default investment alternative, you may be required to furnish additional notices.

You may also want to give employees a more thorough rundown of your retirement plan. Consider including a “Retirement 101” section in your next open enrollment presentation or all-hands meeting. Doing so could boost 401(k) plan utilization, promote financial literacy, and help dispel misconceptions employees might have about your overall benefits package.

Step 4: Keep it running smoothly

Ongoing nondiscrimination testing

Offering a retirement plan takes regular upkeep and a close eye on 401(k) plan compliance deadlines to ensure you don’t run afoul of ERISA and IRS rules. Most 401(k) plans are required to pass nondiscrimination testing each year. These look at the value of each employee's account, employee contribution rates, and other details. Employer matching and profit sharing also come under scrutiny. Your company may also want to regularly review or revise your plan features as the company's situation changes.

Government filings

In addition to keeping up with compliance testing, you’ll need to file an IRS Form 5500 each year. This federally-mandated form includes information about your business, your retirement plans, number of participants, and more.

FAQs

How much will a small business 401(k) cost?

Guideline 401(k) starts at a $39 base fee plus $4 per employee per month. Learn more about our fees and services here.

When evaluating a small business 401(k), consider if there are hidden fees for key functions such as compliance, recordkeeping, and investment management. Also ask about setup fees, monthly fees, annual fees, Form 5500 fees, and whether a provider expects you to pay fees to anyone else. All these standard services are included in Guideline's pricing.

Are there any fees for employees?

Many providers put a lot of the burden for their services on employees, or force employees into investments with high management fees. Ask what fees employees pay. Are there monthly fees or management fees? And what kind of fees are charged by the funds in their portfolios?

For small business plans, the average employee fees are around 1%, but some providers have fees as low as 0.07%. Getting a good answer to this question could mean hundreds of thousands of additional dollars in each employee’s retirement account over the course of several decades.

There’s a lot to consider when setting up a small business 401(k). If you’re currently researching providers, our checklist is below