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How to Set up a 401(k) Plan for Small Business

How to Set up a 401(k) Plan for Small Business

Benefits are an important part of an employee’s compensation package. One popular benefit you can offer is a retirement plan for employees. In the private industry, about 66% of workers have access to retirement benefits. Of the retirement plans you could offer, 401(k) plans are the most popular. Learn how to set up a 401(k) plan for small business.    

About 401(k) plans

A 401(k) plan is an employer-sponsored retirement option that lets employees contribute pre-tax dollars to their accounts. As a result, the contribution reduces an employee’s tax liability while letting them save for retirement. When the employee reaches a certain age, they receive distributions from their account.

There are different types of 401(k) plans:

  • Traditional 401(k) plans
  • Safe harbor 401(k) plans
  • SIMPLE 401(k) plans
  • Solo 401(k) plans

You can also offer a Roth 401(k), which is like a traditional 401(k) plan. However, funds contributed to a Roth 401(k) are on a post-tax basis, meaning you take taxes out of the employee’s wages before taking out their contributions.

Your employer responsibilities will vary depending on the plan you choose. You have the same core 401(k) setup responsibilities regardless of which plan you establish at your business. If you’re wondering how to set up a 401(k), read on.

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

Some employer responsibilities come with setting up a 401(k) plan for a small business. You might be met with some fees for establishing the plan.

Establishment fees can range from $1,500 – $3,000 but could be more or less depending on the business. Some companies might be able to get the fee waived, but this is typically reserved for large businesses.

To set up a 401(k) plan, there are different steps you need to follow:

  1. Decide who is establishing and maintaining the plan
  2. Create a written plan document
  3. Arrange a trust for the plan’s assets
  4. Come up with a recordkeeping system
  5. Distribute plan information to eligible employees

How to Set up a 401(k) Plan

1. Decide who is establishing and maintaining the plan

First, you need to determine if you will set up the plan on your own or turn to a professional or financial institution (bank, mutual fund provider, or insurance company).

Setting up the plan and maintaining it yourself will be more cost-efficient, but it could take up more of your time. Weigh the pros and cons of outsourcing before choosing who you want to set up and operate your business’s 401(k) plan.

2. Create a written plan document

Unless you hire a professional or financial institution to establish and maintain the 401(k), you will need to create a written plan document. If a professional or financial institution is handling the plan for you, they will write the written plan.

The written plan needs to have all the terms and conditions of your 401(k) plan. It is a legally binding document, so you might want to turn to a professional for help.

Your document needs to list what type of 401(k) plan you have decided on and what features you want the plan to have (i.e., employee eligibility and contribution amounts). And, you need to detail the process of contributing and distributing funds.

3. Arrange a trust for the plan’s assets

One requirement for starting a 401(k) plan is that you set up a trust to hold assets. This guarantees that the funds are only used by the participants and their beneficiaries.

When arranging the trust, you need to select a trustee. Deciding on a trustee is an important part of establishing a plan, as they must handle contributions, plan investments, and distributions.

4. Come up with a recordkeeping system

You must come up with a way to keep track of employee and employer contributions, earnings and losses, plan investments, expenses, and distributions.

If you outsource the plan to a professional or financial institution, they will handle recordkeeping on your behalf. If you’re doing it yourself, you might consider using payroll software or SaaS payroll services.

Your recordkeeping system is important for preparing annual reports, which you are required to do.

5. Distribute plan information to eligible employees

In order to get employees to participate in your business’s 401(k) plan, you need to let them know about the plan. Disclose information like the plan’s benefits, features, and employee’s rights.

Prepare a summary plan description (SPD) to distribute to qualifying employees in the 401(k) plan. This lets eligible employees know what to expect out of the plan.

The SPD should have information on employee eligibility, contributions, when it is vested, distributions, claims, and employee rights and responsibilities.

Maintaining your business’s 401(k) plan

Figuring out how to start a 401(k) for a small business is just the beginning. Keep in mind that there are some recurring employer responsibilities after starting a 401(k) for a small business.

Depending on the type of 401(k) you selected, you will need to conduct nondiscrimination testing, make employer contributions, report plan information, and keep up with fees.

Testing

If you have a traditional 401(k) plan, it is subject to annual 401(k) testing to ensure all employees benefit, not just highly compensated employees.

There are two types of tests you need to conduct: Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests. These tests compare salary deferrals of highly compensated employees to non-highly compensated employees.

Contributions

You are required to make employer contributions if you have a safe harbor or SIMPLE 401(k) plan. Keep in mind that there can be penalties for late 401(k) contributions.

Report

For most 401(k) plans, you need to file Form 5500, Annual Return/Report of Employee Benefit Plan (Form 5500-SF or Form 5500-EZ if applicable). This annual return is done electronically.

You need to distribute reports to participants, as well. Give a summary of material modification (SMM) when employees make changes. And, distribute an individual benefit statement (IBS) to show plan participants their total benefits. Lastly, distribute a summary annual report (SAR) when you file Form 5500 so participants know what you reported to the IRS.

Fees

Keep in mind that the price you pay for a 401(k) plan doesn’t stop with setting it up.

There are three types of fees you might face while maintaining your 401(k) plan at your business: plan administration fees, investment fees, and individual service fees.

Why starting a 401(k) plan for a small business is beneficial

Setting up a 401(k) plan can be an important part of your employee benefits package. A 401(k) plan can help attract and keep employees.

One study found that 31% of employees prefer a 401(k) plan or another retirement plan over a pay raise. Because contributions to a 401(k) plan (excluding Roth) are made on a pre-tax basis, each participating employee reduces their tax liability, which could mean more money in their pocket.

When you have a 401(k) plan at your small business, you will need to keep track of employee contributions. Simplify your recordkeeping responsibilities with Patriot’s online payroll software. Our software takes out deductions from employee wages so you don’t have to. Try it for free today!

This is not intended as legal advice; for more information, please click here.

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