Thinking of starting a 401(k) plan? Great! Not sure when to actually start it? No problem.
While many business owners want to start as soon as possible, starting a plan early in a calendar year tends to make that first year go more smoothly. Here are some reasons why starting a new 401(k) at the beginning of a new year can be a smart idea.
1. Employees will have the full year to make deferrals.
In general, you can only defer out of paychecks received after the 401(k) plan starts. You can't retroactively make deferrals from pay you have already received. So if an employee doesn't make enough to reach their deferral limit* from the start of the plan to the end of the year, they won't be able to max out for that year.¹
As a business owner with a high income, you might be able to max out your contributions. But if your employees don't have the compensation or ability to max out their contributions, your plan may have nondiscrimination testing issues (see #3 below).
*For 2026, the deferral limit is $24,500 plus catch-up if eligible. The deferral plus catch-up for those over age 50-59 and 64+ is $32,500; for those age 60-63 it is $35,750.1
2. Employer matching contributions may be limited otherwise.
Many people think they can still take full advantage of an employer match late in the year, by contributing larger sums of money in just a few months. But many 401(k) plans (including Gusto 401(k) plans) calculate matching on a per-pay-period basis. For these plans, your matching contribution is calculated based only on that pay period's contribution—not the whole year. Some plans include a 'true-up' provision that recalculates the match against annual compensation and deferrals, which can offset this effect. However, since Gusto Retirement does not currently support true-up provisions for matching contributions, the example below assumes the plan has no true-up.
Let's look at an example:
Adam's Apples sets up a 401(k) plan to start November 1, with 4 pay periods left. They provide a dollar-for-dollar match up to 5% of an employee's deferrals. Adam makes $250,000 in W2 wages and contributes $12,500 over those 4 pay periods (which is a 30% contribution rate, but 5% of his annual salary). Adam’s pay is spread equally over all of his pay periods for the year.
At a quick glance, it seems like Adam would get $12,500 in employer matching, as well. But since it's a per-pay-period match, Adam will only get a match of up to 5% of the pay he receives for those 4 pay periods. In each pay period he deferred 5% of his $10,416.67 pay, resulting in $520.83 in match per pay period for a total of $2,083 for the year. Whereas, he would get a match on the full $12,500 if he contributed the same amount over the entire year.²
If you start your plan on January 1, you can generally avoid this confusion for your employees and prevent a lot of frustration. Most employees tend to spread their contributions throughout the year to keep things manageable. Be sure to also inform your employees of how the per-pay-period match works, even if it's January, so that certain strategic employees understand not to front or backload their contributions for the full year.
3. Nondiscrimination testing is more predictable.
Many business owners intend to put as much money as they can into their accounts before the end of the year. The biggest problem comes when most of their employees aren’t able to do the same thing. When you have a big discrepancy between the contributions of owners and highly compensated employees, versus those of other employees, you will most likely have a problem with nondiscrimination testing — which can result in owners or highly compensated employees having to remove all or part of their deferrals as well as unexpected costs to the employer.⁵
In a short plan year, there's not much time to figure out whether your plan will pass or fail nondiscrimination testing. Starting a 401(k) plan on January 1 will give you a full 12 months to monitor your plan's activity and assess its compliance testing risk. Some plan providers, like Gusto Retirement, will conduct preliminary testing for you throughout the year so that you can strategize on how to best make your plan work for your company.3
4. Safe Harbor plans can't be started after October 1.
Many business owners avoid nondiscrimination issues by setting up a Safe Harbor 401(k) plan. These are especially great for small businesses, since fewer employees make it harder to pass testing. The deadline to set up a new Safe Harbor 401(k) plan that will be effective in that year is October 1 (assuming a calendar plan year). This is because regulations require that there be at least 3 months in the first plan year in order to include a safe harbor provision. Any plans that start after that aren't eligible for Safe Harbor status. There is a small exception to this rule for a newly established employer.4
As a business owner, starting your plan as Safe Harbor on the first day of the following year is a great way to have a clean benefit offered for the full year to employees, while helping minimize compliance headaches.⁴
5. Changing with other benefits keeps things clean.
Finally, sometimes it just makes sense to start a new benefit at the start of the new year. Many companies switch benefits providers or start new benefits on January 1 of any given year. Your employees might appreciate being able to learn about their health, retirement, and other benefits all at once, and not have to remember different start dates for different benefits.
There are many reasons why a January 1st start to your 401(k) might make sense, but that doesn't mean you have to wait until the last minute to set one up. Gusto Retirement can help you with all the details several weeks before the plan starts, so that you won't be rushed through the process.6
FAQs
Why is January 1 a good time to start a 401(k) plan?
Starting on January 1 gives employees the maximum time to contribute toward the annual limit, so that employer matching is calculated across all pay periods (not just a few), provides a full year for nondiscrimination testing monitoring, and keeps benefit communications clean by aligning with other annual benefit changes. Mid-year starts introduce limitations on all of these fronts.
How does per-pay-period matching work, and why does it matter when you start?
With per-pay-period matching (the most common structure), the employer match is calculated based on each individual paycheck's contribution, not the employee's total annual contribution.
This means an employee who starts late and tries to "catch up" by contributing a large percentage in a few pay periods won't receive the proportionally larger match they might expect. Starting January 1 allows matching to be spread evenly across the full year.
This assumes the plan does not include a 'true-up' provision that recalculates the match against annual compensation and deferrals, which can offset this effect. Gusto Retirement does not currently support true-up provisions for matching contributions.
What is nondiscrimination testing, and why does timing matter?
IRS nondiscrimination testing is intended to confirm that 401(k) plans don't disproportionately benefit business owners and highly compensated employees (HCEs) compared to other workers. Starting mid-year leaves little time to detect and correct imbalances before year-end testing deadlines, which can result in unexpected costs. A January 1 start gives plan sponsors the full year to monitor contribution patterns and course-correct if needed.
What is the Safe Harbor 401(k) deadline, and why does it affect plan start dates?
The deadline to establish a new Safe Harbor 401(k) plan is October 1 of any given year (assuming a calendar plan year). Plans started after October 1 cannot be safe harbor for that year. Since Safe Harbor plans are a common way small businesses automatically satisfy most nondiscrimination testing requirements, missing this deadline can significantly complicate compliance — making a January 1 start the cleanest option.
Can I still start a 401(k) after January 1, or is it too late?
You can start a 401(k) at any time during the year — there's no legal requirement to start on January 1. However, a mid-year start comes with tradeoffs: employees have less time to contribute toward annual limits, per-pay-period matching reduces the employer match benefit, nondiscrimination testing is harder to manage, and if it's after October 1, a Safe Harbor plan is off the table. Planning ahead for a January 1 start avoids all of these issues.
Disclosures
¹ May be adjusted annually to account for IRS cost-of-living adjustments. Learn more.
² The example provided may not be representative of the experiences of all customers and does not guarantee future results. The information provided is general in nature, is provided for informational purposes only, and should not be construed as investment, tax, and or legal advice. Clients should consult a qualified investment or tax professional.
³ All plans of related entities must be administered by Gusto Retirement in order to provide compliance testing.
⁴ For informational purposes only. This should not be considered financial, tax, or legal advice. Contact a financial professional to evaluate what retirement plan is best suited for your situation.
⁵ This content is for informational purposes only and is not intended to be taken as tax advice. Please contact a tax professional for further information.
6Recordkeeping services for Gusto’s 401(k) and SEP IRA/IRA products are offered by its affiliate, Gusto Retirement Services, LLC. 3(16) plan administrative services are also offered by Gusto Retirement Services, LLC and only made available to clients who use the integration services available through Gusto’s payroll service. Gusto Retirement Services, LLC uses a third-party to provide custodial services.
