Industry Trends

How to Advise Clients on 401(k) Basics and If They Should Start One

Gusto Editors  
401(k) small business

Have you been wondering whether or not you should advise your small business clients on a 401(k)?

Here at Gusto, we want our clients to have all the available information and support they need to thrive as business owners and financial advisors. That’s why we’re thrilled to bring you expert knowledge about 401(k)s

A recent webinar “401(k)s and Why Small Businesses Should Start a 401(k)” provided premium education for accountants on equipping individuals with a well-rounded understanding of retirement investments and the pros and cons of starting a 401(k) for a small business.

The host for this event was Nicolle Willson, Head of Retirement Consulting at Guideline. She walked through the ins and outs of 401(k)s, how they benefit small businesses, how the SECURE Act and the CARES Act are impacting retirement investments, and all about non-discrimination testing.

This article covers 401(k) basics and why small businesses should start one. In the second article, we dive into how the SECURE Act and CARES Act affect 401(k)s for SMBs. And finally, the third article goes over non-discrimination testing for 401(k)s and the safe harbor plan.

What you need to know about retirement investments

According to a 2019 AARP article, 48% of Americans aged 55 and older don’t have any retirement funds at all. That means nearly half of the country’s population that is in or nearing retirement doesn’t have money set aside for retirement. 

Nicolle emphasized the gravity of this situation and explained how it could impact our economy.

The consequences of this saving shortfall could be really severe for both individuals and the economy at large. Retirees may be forced to live in relative poverty or rely on families, charities, or the government for income.

Nicolle Willson 
Older couple reviewing documents on an ipad

Further information discovered by Kevin Busque, CEO of Guideline, established that there are more than 5.8 million small businesses. Small businesses are defined as having 1 to 99 employees. In this country, small businesses employ 42 million people. So when you look at small businesses as a whole, they make up 99.7% of all employers in the U.S. Of these 5.8 million businesses, 90% of them do not offer a 401(k) plan. 

So the question is, “Why do we see this huge disparity in access when we compare businesses with under 100 employees to businesses that just have even 500 employees?” It’s mostly because traditional 401(k) providers get paid on what are called “assets under management,” or AUM. AMU is the total amount of money that’s invested in the 401(k) plan. So the smaller the account value, such as a small business that is starting a new 401(k) and has $0 in assets, the less interested a 401(k) provider usually is to win that business.

That’s why you often see small businesses being required to pay a lot more, either out-of-pocket or a higher AUM fee. This charge is almost 2% for small accounts instead of the typical 0.5% required of bigger accounts. 

Just because very few small businesses have a 401(k) doesn’t mean that you shouldn’t either! There are incredible benefits for both you and your employees that come with having one, which we will get into in the following section. By meeting with a financial advisor, you can be guided to providers and resources, such as Guideline, who are pioneering investment options that have the best interest of small businesses in mind. 

How to set up a 401(k) plan for a small business

Even though setting up a 401(k) today requires quite a bit less paperwork and headache, it’s still a commitment. However, we believe it’s a worthy commitment. If you’re still on the fence about starting a 401(k), consider the following three ways it benefits small businesses, business owners, and employees. 

#1 Benefit of Offering a 401(k): Attracts and retains top talent.

Having a 401(k) plan gives you a competitive advantage against 90% of other small businesses for recruiting and retention. There have been studies that show most workers are going to pick a company with better benefits, that include a 401(k), over a company that just offers higher pay with no benefits. 

#2 Benefit of Offering a 401(k): Employee job satisfaction.

Retirement benefits are the third most requested benefits by employees. This request directly follows a request for health insurance and paid time off. A 2017 study by the Employee Benefit Research Institute also found that almost 6 in 10 workers who are extremely satisfied with their benefits are also extremely satisfied with their jobs. 

#3 Benefit of Offering a 401(k): Tax savings at both the individual and the company level.

Business owners are both employers and employees of their business, so they get to take advantage of both.

Let’s talk more about tax savings with the 401(k). For employers, there’s a great tax credit for the first three years of starting a new 401(k) plan. Since this tax credit was recently increased by the SECURE Act, we’re going to talk more in detail about this in Part Two when we go over those provisions. For now, you need to know that employers will also have the ability to make employer contributions to the plan if they want to. These contributions can be either from matching or profit-sharing.

Nicolle said that employer contributions are extra beneficial to small businesses because they are more tax-efficient:

“Employer contributions are more tax-efficient than an outright bonus to employees, and they generally end up with the employee getting more money out of the same nominal contribution. Employer contributions are going to be free of federal and state income tax, as well as payroll taxes to the employer.”

Nicolle Willson

Employer contributions are tax-efficient for the employee as well because they are not reported as income to the employee in the year made.

For employees investing in their 401(k), they can contribute up to $19,500 of their own pay in 2020 and an additional $6,500 if they are aged 50 or over. The 401(k) gives them the advantage of automatic savings, which means employees set a contribution rate and it automatically comes out of their paycheck every pay period. They can also choose to contribute money to either a pretax or a Roth account.

If you’re ready to start a 401(k) for your small business, Gusto and Guideline can help! We’ve partnered together to offer a fully integrated 401(k) system.

When is the best time to start a 401(k)?

While there are many reasons small businesses should open a 401(k), that doesn’t mean you should jump into it without weighing the pros and cons. Here are a few questions you should ask when figuring out the right time to add a 401(k) benefit to your SMB. 

Question #1: What are the company’s current benefit offerings? 

If you don’t have health insurance yet, probably add that first and then look into adding a 401(k). As we mentioned earlier, a retirement plan is the third benefit most potential employees ask for; health insurance and paid-time-off are typically requested first. 

Question #2: Has the company offered a 401(k) plan before? 

Business owners might be scared about opening a new 401(k) if they’ve tried before and it was too much work. However, the 401(k) industry is kind of different than it was five years ago. There are a lot more modern options that are going to help relieve those old administrative burdens, and it’s really very painless to offer one now.

As you’re considering this, you do want to be careful of what’s called the “successor plan rule.” If your business has previously operated but also terminated a 401(k) plan, you won’t be able to start a new 401(k) plan for at least 12 months after that termination date. If you are a financial advisor, it’s really important to be aware of this rule. 

Male bake shop owner sitting at desk reviewing notes in a note book

Question #3: Are business owners looking to contribute to their own retirement? 

Again, business owners will also be their own employees, so they can derive as much benefit, if not more, as their other employees from saving in that 401(k).

Nicolle pointed out that if you’re a company that is experiencing and looking toward big growth, adding a 401(k) plan might be instrumental to helping your business thrive!

“If a company is in a big grow-smart spot, they may be the perfect candidate to start a 401(k). Growing companies often want great benefits to attract more employees. And then they’re also often in a better position financially to offer one.”

Nicolle Willson

Finally, if you’ve never offered a plan before, you can basically start one at any time during the year. However, the earlier you start, the more time and more money your employees will be able to contribute before they hit that year’s limits. So the earlier in the year you set one up, the better.

Learn more about 401(k)s and why a small business should start one!

There are a number of ways 401(k)s add value to small businesses and are easier than ever to set up. Especially during this unprecedented time, individuals are looking to work for companies who are looking out for their employees. Setting up a 401(k) for your business will set you apart as company people want to work for, and it will also give you — the business owner — a tax advantage. 

For all you financial advisors out there — in the last couple of years there have been 401(k) providers, such as Guideline, who have removed the middle man. This means that these providers are able to offer 401(k)s without the large fee that forces most small businesses to avoid them. Make sure you know who they are so that you can connect the businesses you advise with them!

If you want to learn more about 401(k)s and how they benefit small businesses, make sure to check out the full webinar here.

Additionally, make sure to check out Part Two of this webinar article series “How the SECURE Act and CARES Act Affect 401(k)s for SMBs” and Part Three “Non-Discrimination Testing and Safe Harbor 401(k) Plans, Explained” for valuable information regarding 401(k)s and how COVID-19 legislation will impact retirement investments.

Updated: March 25, 2022

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