If you’re wondering how to set up a 401k for employees, you’re on the right track, since access to retirement savings plans consistently ranks as one of the most desired employee benefits.
What you’ll learn
What you’ll learn
Key takeaways
- Common 401(k) plans include traditional, SIMPLE, and Safe Harbor – each designed for different business needs.
- Setup requires a plan document, trust establishment, and employee documentation.
- Starting in 2025, automatic enrollment in new 401(k) plans becomes mandatory for all new employees.
Just because you’re a small business doesn’t mean you can’t help your employees save for retirement. In this guide, we break down how to set up a small business 401(k) plan.
Understand the different types of 401(k) plans
A 401(k)s is not a one-size-fits-all solution. The best 401(k) plan for your small business depends on your particular situation. Some of the factors that can influence the implementation plan for your business include the size of your business, your willingness to match employee contributions, and your own retirement savings.
Are you struggling to determine the right 401(k) plan for your employees? Below, we break down the primary types of 401(k) plans – with help from Tom Brock, a licensed CPA and CFA charterholder with extensive experience advising small business owners.
There are three primary types of 401(k) plans.
Traditional 401(k)
With a traditional 401(k) plan, employees contribute pre-tax dollars from their paychecks, which reduces their taxable income. Moreover, contributions are allowed to be invested in stocks, bonds and fund-style vehicles and grow on a tax-deferred basis throughout the employees’ working years. However, during retirement, withdrawals are taxed. Moreover, any withdrawals made prior to normal retirement age are subject to taxation plus early withdrawal penalties.
Tom’s take on why this plan could be the right fit for your small business
A traditional 401(k) plan makes the most sense for small businesses that want flexibility in plan design and employer contributions. This type of plan allows the sponsor to implement discretionary matching, profit-sharing, and vesting schedules, making it ideal for companies that want heightened ability to manage employee-related expenses, while rewarding employees.
Keep in mind
However, with a traditional 410(k) plan, the sponsor must pass annual nondiscrimination compliance tests to ensure contributions do not disproportionately favor highly compensated employees. This adds administrative complexity for human resources personnel.
— Tom Brock, CPA, CFA
SIMPLE 401(k)
A SIMPLE 401(k) combines the features of a traditional plan with the simplicity of a SIMPLE individual retirement account (IRA). An employee may elect to defer some compensation into a retirement plan but, unlike a traditional plan, an employer must either make a matching contribution of up to 3% of the employee’s pay or a non-elective contribution of 2% of each eligible employee’s pay.
To establish a SIMPLE 401(k) you must meet the following criteria:
- Have 100 or fewer employees
- Have no other retirement plans
- File a Form 5500 annually
SIMPLE 401(k) plans are not subject to nondiscrimination tests and offer a straightforward benefit formula that makes them relatively easy to administer.
Tom’s take on why this plan could be the right fit for your small business
A SIMPLE 401(k) plan is a sound choice for small businesses with 100 or fewer employees that seek to maintain a relatively low-cost and easy-to-administer retirement plan.
Keep in mind
Organizations that are considering this type of plan should note that it requires mandatory employer contributions, but it exempts businesses from annual compliance testing.
— Tom Brock, CPA, CFA
Safe Harbor 401(k)
A Safe Harbor 401(k) is a retirement savings plan in which an employer automatically contributes a set percentage of eligible employees’ salaries to their 401(k). This allows an employer to avoid IRS nondiscrimination tests typically associated with traditional 401(k) plans. By ensuring a standard, automatic contribution across all employees, a Safe Harbor 401(k) plan mitigates the risk of compliance issues.
If you use a Safe Harbor 401(k) plan, you must satisfy certain notice requirements. If each eligible employee for the plan is given written notice of their rights and obligations under the plan at least 30 days and not more than 90 days before the beginning of the plan each year, you should be in the clear.
Tom’s take on why this plan could be the right fit for your small business
A Safe Harbor 401(k) plan is sensible for small businesses that want to avoid nondiscrimination compliance testing, while maximizing contributions for owners and highly compensated employees
Keep in mind
Companies that are considering this type of plan want to know that it requires mandatory employer contributions, either via a 3% non-elective contribution or a matching formula, and these contributions must immediately vest.
Now that we better understand the ins and outs of each of these savings plans, let’s talk about the steps to set one up.
Setting up 401(k) for employees
Retirement benefits are a highly valuable perk; so, it’s a great idea to set up a 401(k) plan for employees. The basic steps involved in setting one up are as follows:
- Clarify your motivations for offering a 401(k): Your motivations for starting a retirement plan will impact the type of plan you choose. Do you want to contribute a small amount to every employee’s retirement savings? Do you want to incentivize high earners with better retirement benefits? Before you start, it’s crucial to understand why you want to set up a 401(k).
- Create a comprehensive plan document: The plan document is the foundation for your 401(k) and should outline the plan’s details, including the type of 401(k), employee eligibility criteria, and contribution levels. It’s a good idea to hire a financial institution or retirement planning professional to help you create this document.
- Establish a trust for plan assets: You need a trust to hold the plan’s assets and guarantee they’re used only for the benefit of plan participants. Elect a trustee to diligently manage the plan’s contributions, investments, and distributions.
- Provide a summary plan description (SPD): An SPD includes information about employee rights, plan benefits, and features. After setting up the 401(k) plan, you must provide this information to all eligible employees, including all future employees.
- Consider automatic enrollment for future compliance: Starting in 2025, all employers must automatically enroll new employees in 401(k) plans offered. That said, employees can choose to opt out.
What are the tax benefits of a 401(k)?
401(k) plans offer tax benefits for both employers and employees. For employers, contributions are deductible on federal income tax returns – up to a maximum amount. For employees, all contributions and investment growth on the contributions are not taxed until they withdraw the money (presumably, in retirement). Collectively, these features give you a tax break each year contributions are made to the plan and allows you to grow your next egg at an accelerated clip.
What employees will want to know
How do employee contributions work?
Employee contributions to 401(k) plans are made with pre-tax dollars. That means the money goes into your retirement account before it’s taxed. Every dollar you contribute lowers your taxable income by an equal amount, which reduces your tax burden for the year.
Can employers match contributions?
Yes, employers can match employee contributions, but it’s not always required. 401(k) matching is generally a great perk for employers to offer, because it’s basically bonus compensation that supports an employees’ retirement goals. If an employer does match contributions up to a percentage of an employee’s salary, it’s important to advertise that perk to potential and current employees!
What happens to a 401(k) when an employee leaves the company?
When an employee leaves a company, they have several options. They can leave the account where it is and take comfort in knowing the former employer will provide ongoing administration of the plan. An alternative option is to roll the plan over to a new employer’s 401(k) (on a pre-tax or after-tax basis). A third option is to roll the plan over to a traditional or Roth IRA. Depending on your circumstances, any one of these options could be optimal. Whatever you do, do not withdraw the money from your old 401(k) plan in a way that is not endorsed by the IRS. Doing so will expose you to unnecessary taxation and early withdrawal penalties.
Takeaway: Employers have choices in 401(k) plans for employees
A 401(k) plan is more than just a nice thing to offer your employees. It can be a difference-maker when it comes to attracting and retaining talent. Plus, eligible small businesses can take advantage of tax credits to help offset startup costs for establishing a retirement plan. If you’re interested in starting a 401(k) plan, OnPay’s retirement partner, Guideline, makes it easy to get started with seamless payroll integration and simplified plan administration. And as your business grows, you can always opt for more robust plan features and administrative capabilities.
If you haven’t started using OnPay, now’s the time to check out our HR management and payroll tools. They are designed to help your small business thrive. Best of luck as your pick the 401(k) plan that makes the most sense for your needs and our team is here to help!
Take a tour to see how easy payroll can be.
Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.