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401(k) Basics for SMBs: Tax Savings, Set Up, and Operations

Gusto Editors  
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Are your small business clients securing their employees’ futures?

The future comes with many unknowns. Society constantly evolves to a new version of itself, and sometimes it is hard to keep up. One thing that remains constant, however, is the need to prepare for the future regardless of what it brings. According to a 2019 AARP article, 48% of Americans 55 and older have no retirement funds at all. The consequences of this savings shortfall could be severe for individuals and the economy at large. If you want to learn more about how to help your small business clients offer retirement plans, this article series is for you! 

We at Gusto are happy to have partnered with CPA Academy to present an informative article series about retirement plan options for you and your clients. The webinar “401(k) or SEP IRA” took an in-depth look at ways to secure the future through investment under the guidance of Nicolle Willson.

Nicolle Willson is the retirement consulting director at Guideline, a 401(k) and retirement solution for small business owners. If you are currently looking for a retirement option to offer your clients, Guideline’s platform provides easy-to-use retirement investment options and seamlessly integrates with the Gusto payroll platform. 

In this article, we will look into how to set up a small business 401(k), 401(k) for small business owners, and 401(k) tax savings.

How to set up a small business 401(k)

Historically, 401(k) plans have not been the most effortless investment accounts to establish. Still, modern providers work hard to make the process as painless as possible for employers and their workers. Providers work with small businesses to effectively follow the steps they need to offer quality plans for their employees.

The first step in the process is to adopt a written plan document. This document outlines basic policies and agreements of the plan:

“First, you have to sign and adopt a written plan document. The plan document is the foundation for your day to day operations, and fiduciaries are going to be bound by the terms of the plan document when operating the plan.”

– Nicolle Willson

After you establish the plan, you need to establish a trust fund for the plan’s assets and name a trustee. The fund gives you a location to deposit the money for investment growth, and the trustee handles transfers in place of the investor:

“Next, you need to establish a trust fund for the plan’s assets. The assets must be held in a trust to ensure that they are used solely to benefit participants and their beneficiaries, and then a trustee must be named. Generally, the trustee should be an individual that has a high level of responsibility in the company and can be held personally liable for claims.”

– Nicolle Willson

Once businesses establish a trust fund and name a trustee, you need to develop a record-keeping strategy. This system keeps track of every transaction in the trust after being established.

“Third, you will need to develop a recordkeeping system. [The system] must keep track of contributions, earnings, losses, distributions, expenses, and participant accounts. Some plan providers will include recordkeeping services, and a third-party administrator can also do so.”

– Nicolle Willson

The last step in establishing a 401(k) is providing the plan information to your employees who are eligible to invest. When creating this plan, make sure you include all possible options for your employees:

“Finally, you will need to provide plan information to employees. You have to notify employees who are eligible to participate about the plan’s benefits. Generally, you would be using a summary plan description. This is a readable summary of the plan document. If your plan has any special features such as safe harbor contributions or auto-enrollment, you may also be required to provide specific notices for those features.”

– Nicolle Willson

Once a business establishes a 401(k) plan, fiduciaries need to be hired to maintain and protect the employee’s investments. Following the proper steps gives businesses confidence in retirement investing and security for their employees’ financial futures.

Shot of business people working on a laptop in an office

401(k) tax savings and employer contribution

When working with 401(k) investment plans, employers gain new ways to reward their employees. Traditional bonuses require taxes to be drawn immediately on the amount you give to your employees. When employees have a 401(k) option, employers have the opportunity to offer employer contributions to the investment account rather than paying out traditional bonuses. Employer contributions open the possibility to offer your employees tax-free incentives that make employees more money in the long run. 

“Employer contributions are more tax-efficient than an outright bonus, and they generally end up with the employee getting more money out of the same nominal contribution. Employer contributions are free of federal and state income tax and also free of payroll taxes to the employer. They are also not reported as the employee’s income that year. Employers can contribute up to $58,000 in 2021 to each employee’s account, minus any employee contributions.”

– Nicolle Willson

The tax savings from 401(k) accounts offer more benefits to employers beyond offering tax-free options. They also allow the employee to contribute to the account. Workers can deposit lump sum contributions to the investment account and opt to have a percentage removed from each pay period:

“For employees, they can contribute up to $19,500 of their pay in 2021 and an additional $6,500 if they are 50 or over. The 401(k) also gives the advantage of automatic savings, which means employees just set a contribution rate, and it comes out automatically from their paycheck every pay period. Usually, this means workers get used to not having that money to spend and makes it easier for them to save regularly.”

– Nicolle Willson

Employees also retain the option to pay tax on their investments immediately with each pay period or have taxes removed as part of their income. These options allow investors to analyze their income and choose when they want tax removed from their investment. 

“Employees can also choose to contribute money to either pre-tax or a Roth account, assuming the 401(k) offers both. If pretax, the money comes out of their pay before taxes are taken. It grows tax-deferred in the account, and then taxes are assessed on any amount withdrawn in the future. If Roth, the workers pay tax on their entire paycheck first, and the money goes to their 401(k) after that. It also grows tax-deferred. When they are ready to take the money out in retirement, it is going to be completely free of taxes.”

– Nicolle Willson

In addition to having tax options, employers have the opportunity to incentivize saving by offering matching contributions. These payments promote higher savings to the account, which results in healthier retirement opportunities for employees. In addition to tax savings, 401(k) accounts hold advantages over other retirement investment opportunities.

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Advantages of 401(k) for small businesses

401(k) investment accounts offer a variety of advantages to their owners. The tax savings allow workers to control how their taxes are removed based on their current tax rate. Choosing pre-tax vs. Roth contributions depends highly upon the investor’s tax bracket. 

“Pre-tax contributions are generally favored by those who are currently in a high tax bracket and may only have a few working years left before retirement. Roth contributions, on the other hand, are usually favored by those who are young, 30-40 years away from retirement, with plenty of time for their earnings to compound. Younger people also tend to [currently] be in a lower tax bracket than they could be in retirement. This makes an immediate tax deduction less attractive.”

– Nicolle Willson

In addition to benefiting the employee with the account, employers have added flexibility in the terms surrounding the contribution of funds. This flexibility gives employers the ability to tailor plans to work best for their businesses: 

“401(k) plans also give employers some flexibility [with] setting eligibility requirements. You can’t set requirements to be more stringent than age 21 and one year of service for employee deferrals. [However], you can set a two-year requirement for employer contributions, but not employee contributions. Businesses can also set a vesting schedule for employer contributions so long as they are no more stringent than a three-year cliff or a six-year graded vesting schedule.”

– Nicolle Willson

Another added feature of retirement investment through 401(k) accounts is security for the investor. ERISA, the Employee Retirement Income and Security Act of 1974, legally supports these accounts. This act passed four years before the development of 401(k) accounts but expanded to include them after the creation of 401(k) accounts:

“ERISA set many rules for retirement plans, including requiring plans to provide participants with certain information such as plan features, investment fees, and other disclosures. It also requires the plans to have fiduciaries. Essentially, those who have a stake in running the plan must act in the sole interest of the plan’s beneficiaries, namely the plan participants. These regulations generally mean the plan providers cannot act in their own best interests and owe a duty of care to the participants.”

– Nicolle Willson

From flexibility for employers and employees to financial securities in ERISA, 401(k) accounts provide a solid option for retirement investment. The advantages surrounding these investment plans give confidence and comfort to those who invest in a 401(k).

Learn more about 401(k) for small business owners

Although the initial setup of a 401(k) may seem daunting, the benefits drastically outweigh the task of establishing the investment account. Employers gain the ability to provide unique, tax-free incentives to their employees, all while providing future financial security. 

“A positive of starting a 401(k) is going to be employee job satisfaction. Retirement benefits are the third most requested benefits by employees, just behind health insurance and paid time off. A 2017 study by the Employee Benefit Research Institute found that almost 6 in 10 workers who are extremely satisfied with their benefits are also extremely satisfied with their jobs.”

– Nicolle Willson

If you would like to learn more about 401(k)s for small businesses, you can watch the entire webinar here. Also, be sure to look out for Part Two and Part Three of this article series to find out more about different types of retirement investment opportunities and which are best for your small business clients.

Our mission at Gusto is to help accountants and their clients gain peace of mind while on their financial journey. We currently partner with over 4,500 firms nationwide to promote security and cultivate a positive work environment. Be sure to look into our People Advisory Program to learn how to connect with your clients beyond their finances. We also provide a partner blog full of resources for all your advising needs. Visit our Gusto for Accountants page for more information on utilizing people-based accounting within your firm.

Updated: March 31, 2022

Gusto Editors
Gusto Editors

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