Start running payroll and benefits with Gusto
Specifically, a 401(k) is a company-sponsored, tax-deferred retirement plan that deducts contributions from employees’ paychecks and then deposits that money into their 401(k) accounts.
When employees retire, they’ll receive regular distributions to supplant their income—and they won’t pay any taxes until then, as long as their 401(k) is funded with pretax dollars.
Do I have to offer a 401(k) as an employee benefit?
No, offering a 401(k) plan isn’t mandatory—although it’s a good way to increase employee retention.
Ensuring that your team feels confident with their retirement incomes can improve their job satisfaction and performance. The average 401(k) return is between five and eight percent. Comparatively, the average return on a 20-year government bond is currently 1.9%.
Just because you don’t have to offer a 401(k) doesn’t mean you don’t need to offer any retirement savings plans. Some states, like California, require certain employers to help employees save for retirement.
You can typically fulfill these requirements with a 401(k), Roth IRA, or other type of retirement plan—and many states are developing public options that will fulfill your legal requirements.
Here are the states that, as of this article’s printing, require you to offer some kind of retirement plan.
|State||Minimum company size||Law start date||Name of state-run retirement program|
|California||Five or more employees||June 30, 2020, for employers with 100-plus employees; June 30, 2021, for employers with 50-plus employees; and June 30, 2022 for employers with five or more employees||CalSavers|
|Connecticut||Private-sector employers with five or more employees||Not yet finalized, but the mandate is expected to begin in 2020||Connecticut Retirement Security Program|
|Illinois||25 or more employees||Employers with 100 or more employees should already offer retirement plans; employers with 25 or more employees must offer plans by November 1, 2019||Illinois Secure Choice|
|Maryland||No minimum company size||Already in effect||MarylandSaves|
|New Jersey||25 or more employees||No start date set yet||New Jersey Secure Choice Savings Act|
|Oregon||No minimum company size||Already in effect for employers with 10 or more employees; November 15, 2019, for employers with five or more employees; and May 15, 2020 for all other employers||OregonSaves|
What types of 401(k) plans can I offer my employees?
There are a number of different small business 401(k) plans out there. So it’s important to do some research so you can pick the one that best suits your company and employees.
You’ll need to answer a few questions before choosing a 401(k) plan for your business.
- Do you want to match your employees’ contributions? While you can match with a traditional 401(k), this also opens up the safe harbor 401(k) option, which doesn’t require annual compliance tests. This can help highly compensated employees max out their retirement contributions. The SIMPLE 401(k) also requires matching your employees’ contributions.
- How big is your company? If your company only consists of you or you and your spouse, consider the solo 401(k), which has minimal compliance requirements. The SIMPLE plan, which also offers reduced compliance requirements, is a great 401(k) for small businesses with less than 100 employees.
You should also understand what the compliance requirements look like before picking a plan. Use the terms below to help you understand each plan’s requirements.
- Fiduciary duty: This means you’re acting for your employees’ benefit, so you have to focus on minimizing extraneous fees, submitting employee contributions on time, and disclosing any relevant requirements to your staff.
- Nondiscrimination testing: This means that you have to make sure 401(k) contributions are proportional regardless of income level. Your highly compensated employees can’t contribute a significantly higher percentage of their income to their 401(k)s (which includes your employer match) than employees who earn less.
- Form 5500: This IRS form reports on your plan’s investment, financial state, and operations. (We’ll get into this in the next section.)
|Name||Restrictions||Contribution limits||Employer match available?||Compliance requirements|
|Traditional 401(k)||No employer restrictions||Standard 401(k) contribution limits||Yes||Fiduciary duty, nondiscrimination testing and annual filing of Form 5500|
|Safe harbor 401(k)||The employer must match or contribute to the employee’s 401(k)||Standard 401(k) contribution limits||Required||Fiduciary duty and annual filing of Form 5500|
|Solo 401(k)||The only employees can be you and your spouse||Standard 401(k) contribution limits||Yes||Annual filing of Form 5500 if assets are greater than $250,000|
|SIMPLE 401(k)||You must have 100 or fewer employees and contribute to your employees’ 401(k)||$13,000||Yes, and you must match employees’ contributions up to 3% or provide a flat contribution of at least 2% of their compensation||Annual filing of Form 5500|
You also might want to consider a Roth IRA or Roth 401(k), which deduct money post-tax. While Roth IRAs (individual retirement accounts) are designed for individuals, if you have employees, your company could offer Roth 401(k)s, which have the same contribution limits as a traditional 401(k), but are deducted from your employees’ paycheck after taxes.
If a large number of your employees would prefer to have a Roth account, this might be something to consider. Learn more about the difference between a Roth 401(k) and a Roth IRA.
If I offer a 401(k), what are my requirements as an employer?
Form 5500 is filed electronically via EFAST2, and is due the last day of the seventh month after the end of the plan year. For example, if your plan year ends December 31, Form 5500 will be due on July 31.
To submit Form 5500, you’ll need to know:
- If your plan is a single-employer plan or a multiple-employer plan that covers several companies. Multiple-employer plans are also referred to as association retirement plans, or ARPs.
- If the plan is collectively bargained
- The name of the plan
- The plan sponsor’s name—typically your company
- The plan administrator’s name—the company that manages your plan
- The total number of plan participants, including the amount who are active at the beginning and end of the plan year
- If any retired, separated, or soon-to-be retired or separated participants will receive benefits
- The number of deceased participants whose family still receives benefits
- The number of participants with account balances
- The number of employees who left your company and weren’t 100% vested
- Information on pension or welfare benefits, if provided
Your company might also receive tax benefits by offering a 401(k). The three major benefits are:
- An up-to-$500-per-year tax credit for the first three years you offer a 401(k)
- Deductions of some administration fees
- Tax-exempt employer contributions, as long as they’re less than 25% of each employees’ total compensation
How much can employees contribute to their 401(k) plans in 2020?
The 401(k) contribution limit for 2020 is $19,500 for employees under the age of 50—although there are several caveats. First, employees over the age of 50 can contribute an additional $6,500, called a 401(k) catch-up, raising their total contribution limit to $26,000.
Including employer contributions, the maximum 401(k) contribution amount for those under the age of 50 is $57,000 or 100% of an employee’s compensation, whichever is lower. For employees over age 50, this maximum limit is $63,500.
The more your employees can contribute, the better—not only will it increase their retirement savings, but it will lower the amount of taxes they owe in April.
What is employer matching?
Once you’ve set up your 401(k), you might want to contribute to your employees’ plans. That’s great. But it can also be confusing.
Many employers elect to match contributions up to a certain point. That means your contributions will be based on your employees’ contributions—although the exact terms are your decision.
Your options include:
- Matching your employees’ contributions dollar-for-dollar until they reach a certain percentage of their salary. (Often 5% or 6%.)
- Matching a certain percentage of your employees’ contributions. For example, you may match 50% of contributions up to 5% of your employees’ salaries—which means, in effect, you’re contributing up to 2.5% of your employees’ salaries.
- Contributing a flat amount to your employees’ 401(k) plans, like $5,000 per year. You can do this and match your employees’ contributions.
Keep in mind that some 401(k) plans, like the safe harbor 401(k) and SIMPLE 401(k), have specific employer-matching requirements. Check out the table above to see what those requirements are.
Still a little confused? Let’s walk through an example.
Jada makes $100,000 per year. Here’s how their 401(k) contributions would shake out with different kinds of matching, assuming they take full advantage of your company’s plan:
- Dollar-for-dollar match, up to 6%: Jada contributes $6,000 per year and you contribute $6,000 per year for a total of $12,000 per year.
- Percentage match — 50% of 6%: Jada contributes $6,000 per year and you contribute $3,000 per year for a total of $9,000 per year.
- Flat contribution of $5,000: Jada contributes $6,000 per year and you contribute $5,000 for a total of $11,000 per year.
What are the 401(k) contribution limits for an employer match?
Your 401(k) matching contributions can’t exceed either 100% of your employees’ compensation or $56,000—whichever is lesser.
The limit rises to $62,000 for employees over 50.
What is profit-sharing?
One unique way to contribute to your employees’ 401(k) plans is through profit-sharing. Essentially, a profit-sharing plan allows you to divide a portion of your business profits among your employees and add that money directly to their retirement savings.
This is great if your company’s finances are in flux, and you’re not sure if you can contribute much to your employees’ 401(k)s on a regular basis. Or, if you want to encourage your employees to share in your company’s success, a profit-sharing plan can be a good motivator.
If you choose a profit-sharing plan, you’ll need to be extra careful during your nondiscrimination testing. Often, employers allocate profit according to each employee’s share of total compensation—which means highly paid employees will receive more money.
Profit-sharing plans are limited to a maximum of 25% of the employee’s total compensation or $56,000, whichever is less.
Not sure how you want to contribute? Here’s the rundown.
|Dollar-for-dollar match||Greatly increase employees' retirement savings and encourage them to contribute more||Can be expensive, especially for high earners|
|Percentage match||Encourage employees to contribute to their retirement savings without spending as much as a dollar-for-dollar match||Employees may not be encouraged to max out their retirement savings to their full potential|
|Flat contribution||Be able to know exactly how much you will contribute to employees' 401(k)s each year||May be less appealing to hirees, especially if the flat contribution is significantly less than a dollar-for-dollar match would be|
|Profit-sharing||Flexible, allowing you to let your employees to take part in your success without sacrificing funds in leaner years||Employees may find the plan confusing or be disappointed if the profit-sharing is less than expected|
What is 401(k) vesting?
Whether you choose to match, offer a flat fee, or enroll in a profit-sharing plan, you’ll need to think about vesting.
If your employee is “vested,” it means they own 100% of their retirement account, including your contributions—and you can’t revoke any money if they leave. Many companies require employees to work for a few years before their account is fully vested, which can incentivize an employee to stay.
The right vesting schedule depends on you and your business. Common vesting options include:
- 100% vesting immediately: Employees own the amount you contribute as soon as it hits their 401(k) account.
- Cliff vesting: Employees remain 0% vested until they reach a designated milestone, such as three years of service. Then, they’re 100% vested.
- Graded vesting: The amount your employees are vested increases every year. For example, in year two they might be 20% vested; in year three, 40%; and so on until they reach 100% vested.
There are two occasions when an employee must be 100% vested: if they’ve reached the plan’s retirement age or if the plan is terminated.
How do I handle 401(k) rollovers when an employee starts or leaves?
If your employee leaves the company, many retirement plans won’t allow them to keep their funds in the same place. They’ll need to roll over their 401(k) into a personal IRA or their new employers’ 401(k) plan.
Generally, your employees will handle their own 401(k) rollovers directly with the plan administrator.
What’s the difference between a 401(k) and a pension?
Before small business 401(k) plans became common in the 1980s, many employers offered pensions, which guaranteed a certain amount of income after employees retired.
Unlike 401(k)s, which are a contribution plan—meaning your employees contribute to their own retirement savings—pensions were a benefit plan. That means the employers were often exclusively contributing, although some plans did require employees to participate, too.
Typically, employees would receive a set, guaranteed amount after retirement, delivered either as a lump sum or as regular income. Generally, employees would have to work at the company for a specific amount of time, such as 15 years, before receiving the full payment.
Often pensions came with conditions, like requiring employees work at least 10 years or providing a set portion of their salary—perhaps 50% or 85%. When pensions fell out of favor, 401(k) plans became popular.
Offering a 401(k) is a fantastic way to help your employees save for retirement. These plans can also help you lower your tax burden—a win-win for everyone.