For a small business, a 401(k) plan is a cost-effective way to promote employee retirement savings while enjoying tax advantages for both the plan participants as well as the employer. This type of Plan gained in popularity in the 1970s after the Employee Retirement Security Act of 1974 was implemented by Congress, placing increased regulatory oversight on traditional Pension Plans. The typical 401(k) plan, also known as a Defined Contribution Plan, differs from Pension Plans in several ways that are beneficial to small businesses, including methods of investing, allocating earnings, and account maintenance.
A primary advantage to small business owners seeking to establish a Defined Contribution Plan for their employees is that this type of plan places the burden of saving and investing on the employee, instead of the employer. Upon meeting the Plan's entry requirements as defined by the Plan Document, the Plan Participant may elect to defer a specified amount of pretax funds from their paychecks. This money is then invested in an individual account on behalf of the participant into investment funds of the employee's choosing. As an incentive to participate in the plan, the employer will usually offer a match on the funds that the employee contributes. This is usually expressed as a percentage of the employee's deferrals. For example, a typical employer match may be 100% of the first 3% of pretax employee deferrals.
From the perspective of a small business owner, establishing and maintaining a new plan will affect the management and culture within the organization for both better and worse. Companies who incorporate Defined Contribution Plans into their employee benefits packages will have an advantage when it comes to attracting and retaining top talent in their staff. In addition, employers are also entitled to take tax deductions on the contributions they make to their employees' accounts, which can aid in offsetting anticipated financial burdens at tax time. Finally, accounts are easily withdrawn or rolled over when a participant terminates employment, easing what would otherwise be a large administrative burden of maintaining the accounts over a long period of time.
Conversely, small businesses who wish to enjoy the benefits of a 401(k) plan must navigate the world of the Internal Revenue Code, which can at times be quite confusing. Annual testing to ensure that the plan is in compliance with current regulations is usually required. Because of this, a small business may want to consider outsourcing the administration of the Plan to a third party service to ensure that it is managed properly, although this may add a significant cost on to the Plan. Because separate accounts are required for each Participant, it is also important for the business to maintain accurate records of all funds going in and coming out of the plan, which can also be administratively burdensome.
When considering a new Plan, it will serve a small business owner well to consider both the pros and cons, meet with investment and financial professionals, and consider a third party administrator should finances allow. Once the Plan is implemented, it becomes a fantastic resource for employees to achieve and maintain financial security. Perhaps more importantly, it is an invaluable way for a small business owner to show care and concern for the security and well-being of employees, leading to a more satisfied workforce and stronger business as a whole.
Continued 401(k) Definitions