401(k) Plan Basics for Small Businesses

Since the 401(k) plan first became popular in the early 1980s, this plan has become a centerpiece of wealth accumulation for American workers. Originally an obscure paragraph in the tax code that allowed companies to defer income and taxation for executives, the 401(k) rapidly moved mainstream. While 401(k)s were once mostly confined to very large employees, recent years have seen thousands of very small businesses adopt these powerful plans. Now, the 401(k) plan can be the optimal solution even for single-person companies and sole proprietorship with no employees.

How 401(k)s Work

401(k) plans are qualified defined contribution workplace pension plans. The term "qualified" means that these plans are governed by the Employee Retirement Income Security Act of 1974, or ERISA. Participants in the plan elect to have a portion of their salaries or wages deducted from their paychecks and invested on their behalf. Income taxes on their contributions are deferred; the money is only taxed as income when the worker withdraws it.

The employer can also make matching contributions on the employee's behalf. These matching contributions will generally "vest" to the employee after five to seven years. Matching contributions are voluntary, however; there is nothing in the law that requires plan sponsors to make matching contributions.

Advantages to Offering a 401(k) Plan

Recruiting and Retention. 401(k) plans are vital for attracting and retaining quality workers. The available retirement plans are a big factor in choosing where to work. A well-designed plan with a company match can be important in retaining valuable, talented workers, who could potentially be lured to another company.

Golden Handcuffs. Additionally, because there is usually a delay between the time matching contributions are made and the time they are vested to the worker, a substantial amount of as-yet-unvested contributions can also act as a powerful incentive for employees to stay with your company, rather than move on to another opportunity.

Loans. 401(k) plans allow sponsors to offer loans to employees. Many employees have relied on 401(k) plan loans to help them with temporary emergencies, or to help finance a large purchase, such as a house.

Offering this benefit does frequently mean some additional administrative burden. For this reason, many smaller companies don't offer this benefit.

Generous Contribution Limits. As of 2012, the maximum allowable contribution to a 401(k) plan is $17,000 per year, plus matching contributions. Workers who are over age 50 can contribute an additional $5,500 in "catch-up contributions. These limits are much higher than those available for IRAs, and there is no income limit on eligibility, as there is with IRAs and Roth IRAs.

A special type of 401(k) plan, called a "Solo 401(k)," is designed for self-employed individuals and business owners with no employees besides the owner and perhaps a spouse. Solo 401(k) plans are popular with these business owners, as are SEP IRAs, because they do allow for such significant contributions - particularly when you take matching contributions into account.

Tax Credit. The IRS is currently providing a tax credit worth up to $500 to offset any expenses associated with starting up a new workplace retirement plan, including a 401(k), for qualifying businesses.

Flexibility. 401(k) plans offer employers the ability to offer a very wide range of investment options for their employees. Frequently, employers will allow workers to select from a variety of mutual funds and other investment vehicles in the following categories:

• Large cap US stock funds
• Small -cam US stock funds
• International funds
• Real estate investment trust (REIT) funds
• Long-term bond funds Short term bond funds
• Guaranteed investment contracts (GICs) Money markets Annuities

Limits and provisions

Under ERISA rules, plan sponsors must offer 401(k) enrollment to all eligible employees. You cannot discriminate in favor of owners or senior management.

Additionally, under "top-hat" laws, senior employees' ability to contribute to 401(k) plans is dependent on workers' contributions. It is therefore in the interests of managers to encourage workers to participate in the plan as much as possible.

Considerations

The 401(k) is an excellent choice if one or more of the following conditions apply:

• You want to attract and retain talent.
• Your work force can afford to set aside a modest amount of income every month
• You want to offer the ability to defer substantial sums
• Your company can offer a matching contribution, either in cash or in company stock
• Ongoing benefits are more important to you than minimizing initial startup costs and administration expenses.
• You want to be able to offer 401(k) plan loans to employees
• You have a dedicated HR person to assist with administrating the plan
• You like the tax benefits of a Roth IRA and would like to expand the amount of money you and your employees can contribute via a Roth 401(k) option.

We are longtime experts in group benefits of all kinds, including 401(k) plans and other retirement options. We are happy to answer any questions you may have, or perform a no-obligation consultation to discover what the best option would be for your business.

For more information, feel free to Contact Neptune Financial to schedule an appointment.

Basic Understanding

This blog is being provided for informational or educational purposes only. It does not take into an investment objectives or financial situation of any individual, family, prospect, client, or prospective clients. The information is not written or intended as investment advice and is not a recommendation about managing or investing your retirement savings.

An individual seeking information regarding their investment or retirement needs should contact a financial professional.

Neptune Financial, and their financial professionals do not render tax and legal advice. Please consult your tax and legal advisors regarding your personal tax or legal concerns.