Key Takeaways:
- Small business owners can benefit from many tax advantages related to opening and maintaining a 401(k) plan.
- Owners, just like their employees, receive the benefits of building savings for retirement including Roth and/or tax-deferred options and will receive any employer contributions.
- When you work with an ERISA 3(38) Fiduciary provider, your liability as a business owner is materially reduced.
- With a 401(k) plan, you can access your money via a 401(k) loan if you really need it, with no penalties or high interest rates.
- Money in your 401(k) account is typically protected from creditors and bankruptcies.
- A 401(k) can help you attract and retain top talent.
A 401(k) is an employer-sponsored retirement savings plan that helps employees and business owners alike contribute for retirement in tax advantaged investing accounts. A 401(k) can make the difference in saving a meaningful amount for retirement and help empower you and your employees to chase more dreams and better care for those you love. 401(k) plans are a popular retirement plan for businesses and employees because they offer flexibility, automatic payroll contributions, high contribution limits, and tax benefits.
What are the Tax Advantages of Offering a 401(k) Plan?
1. Tax Credits
First-Time 401(k) Plan
If you are starting your business’ first 401(k) plan and have less than 100 employees, you can qualify for a minimum of $500 tax credit to a maximum of $5,000 for each of the first three years of your plan. This credit can be applied to 50% of your qualified business 401(k) costs such as plan setup and administration. This credit may be worth $15,000 over three years although providers focused on small businesses tend to be much less expensive. These credits were increased significantly to these current levels in the SECURE Act that went into effect in 2020. Note that Solo 401(k) plans – plan design for the self-employed – do not qualify for these tax credits but may deduct plan costs.
Automatic Enrollment
If you choose the automatic enrollment feature, you may qualify for another $500 per year tax credit for the first three years.
2. Tax Deductions
Employer Contributions
Giving your employees a 401(k) contribution, be it a match, profit share or other, is tax deductible for your business. Matching is typically 100% deductible unless it exceeds 25% of an employee's total income. Matching is not required in a 401(k) plan, but it may cause some restrictions on highly compensated employees in how much they may contribute.
Come tax time, your business can deduct all matching contributions (within the deductibility limitations imposed by the IRS) to employee accounts.
3. Owner and Employer 401(k) Contribution Limits and Options
Owners and executives that contribute to a 401(k) plan get access to the high contribution limits as well as important features like Roth 401(k) and catch-up contributions. And if the owner/employer provide a match or profit share, the owner(s) that participate in the plan receive this too. FYI, there are no earnings limits to take advantage of the Roth 401(k) feature unlike with a Roth IRA.
4. Minimize Liability Concerns for Employers
Every employer takes on fiduciary duties in providing 401(k) benefits for employees at their company. One that can be onerous and can be intimidating, is knowing the rules about the investment offering that can be made available to employees. This includes determining the investment roster, monitoring it ongoing, making and documenting changes, regulatory requirements, and more. Many employers aren’t investment experts -- they don’t want or plan to be – and elect to work with an ERISA 3(38) advisor.
What Is an ERISA 3(38) Advisor?
The ERISA 3(38) advisor takes on the investment management role for your company in managing the investment options made available in your plan. And to clarify from the get-go, the ERISA 3(38) Advisors takes on the fiduciary duty and liability for these investment manager duties. These duties include full discretion of the fund roster made available in your plan to your employees and the ongoing monitoring and adjustments.
The employer, also known as the plan sponsor, relinquishes discretion and influence in the roster decisions. However, the plan sponsor monitors the work of the advisor to ensure the ERISA 3(38) Advisor is performing its duties in line with your advisory agreement and investment policy of the 401(k) plan. The advisor should make this easy for you by providing reports, often quarterly, of all that’s occurring, and any changes being made and why.
It gets better. As long as the plan sponsor(s) are monitoring the work, they are protected from suits and liability for investment roster decisions, and this service saves the company the time, energy, and internal costs of managing the investment roster.
5. Access Money in an Emergency via a 401(k) Loan
Here's a benefit you don't get with an IRA: access to your money when you really need it in an emergency, with no penalties or high interest rates.
Of course, you don't want to remove money from your retirement savings unless it's truly necessary as it can hurt how much you build for retirement. However, with a 401(k) you can have the option of taking a loan. If you enable this feature, you or any of your employees can take a loan of up to 50% of the vested 401(k) account balance up to the maximum amount of $50,000. You will contribute back to your account to pay down the loan typically over a 5-year period. Even the interest you pay on the loan goes back into your account.
Warning: if you were to leave your job, the amount outstanding on your 401(k) loan is typically due within 30-60 days. If you are unable to pay this amount, the amount that remains unpaid will be considered income and taxed at your current tax level plus a 10% penalty. Those over 59 and a half years of age typically are not subject to the tax penalty.
6. Protection from Creditors
401(k) plan monies are typically protected from creditors and bankruptcies. Under the Employment Retirement Income Security Act of 1974 (ERISA), the funds in your 401(k) legally belong to you once you withdraw them to use as income or roll it into a retail account (e.g. an IRA). Until then, your 401(k) money is legally the property of the plan administrator — your employer — who is only allowed to release the monies to you.
7. Portability
You can roll your 401(k) over if you decide to start another company, retire or convert to an IRA if/when you leave the business.
8. Attract and Retain Great Employees
Strong benefits can help retain your team. Research indicates that 61% of employees would leave their current employer for a similar job if it offered better retirement benefits.^ Whether you're recruiting or seeking to keep your current employees, a 401(k) is a terrific incentive.
^ Employee Retirement Study conducted by Wakefield Research for ShareBuilder 401k, August 2018 (this research is getting dated – may be better to reference the cost to replace even one employee who leaves due to benefits is estimated to be much, much more than the price of a 401k plan: https://www.sharebuilder401k.com/overview/cost-of-employee-turnover/
Frequently Asked Questions:
Is it worth the time and energy?
Short answer: Yes.
401(k) plans can help you build your retirement nest egg while also helping you save on taxes. Those providers that offer digital ease and great services teams can make it turnkey for your company to manage.
Are we big enough to afford one?
Short answer: Yes.
A business of any size can have an affordable 401(k) plan, even if you’re self-employed.
Do we need to be financial experts?
Short answer: No.
You can rely on your provider’s financial experts (such as ShareBuilder 401k’s Investment Committee) to manage your plan investment options. It’s called an ERISA 3(38) advisor if you want to ensure you are getting what you want.
Does it cost much?
No. A business of 10 can offer a plan for <$100 per month in administration cost for the business. With tax credit and deductions, it becomes a pretty minimal expense fast! Plans that use low-expense funds (index funds), we believe help put your team in a better position to have a bigger nest egg (by removing the drag of higher fund expense ratios).
For more detailed answers on these and other questions, check out the 7 myths of 401(k)s.
This blog is for general information and is not tax guidance. Please refer to a tax advisor for your tax situation and needs.