A 401(k) is an employer-sponsored retirement savings plan that helps employees and business owners contribute to their retirement. It is named for Section 401, Paragraph K of the IRS tax code. Section 401(k) outlines the rules and guidelines around ERISA (Employee Retirement Income Security Act) employee-sponsored retirement plans such as 401(k)s.
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.
Key Takeaways:
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A 401(k) is an employer-sponsored retirement savings plan that helps employees and business owners contribute to their retirement.
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Businesses of any size can have a 401(k) plan, from the self-employed to businesses with employees.
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Business owners with employees can consider Safe Harbor 401(k)s, Traditional 401(k)s, or Tiered Profit Sharing 401(k)s for their retirement needs. Typically, the choice depends on the size of the business and level of flexibility needed.
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Self-employed business owners can use a Solo 401(k) to maximize their retirement savings.
How Does a 401(k) Work for a Business?
If you decide to offer a 401(k) plan for your business, you’ll need to select a 401(k) provider to offer these benefits for you and your employees. There are many providers to choose from, each offering a level of administration and service for a fee.
To see how ShareBuilder 401k costs stacks up against your current 401(k) plan, check out our Cost Comparison Tool.
Once you select a provider and install your 401(k) plan, you (and your administrators) are now 401(k) “plan sponsors” and are responsible for ensuring that the retirement plan remains in good standing.
After the 401(k) plan is set, employees and owners can contribute a portion of their salary to their retirement account. The contributions are invested in a retirement-appropriate fund lineup, so the money may grow over time.
These regular payroll contributions make use of an investing tactic called dollar-cost averaging. The money contributed to a 401(k) is invested with the goal of growing steadily and ultimately supporting each employee’s retirement.
Money added to a regular 401(k) is contributed pre-tax and isn’t taxed until it is withdrawn in retirement. Many plans also offer a Roth 401(k) feature that allows participants to make after-tax contributions to their plans, so they can withdraw their money tax-free. Withdrawals before the age of 59½ may incur a 10% tax penalty.
What is Employer Matching?
While it’s not required, business owners with employees can also match an employee’s 401(k) contributions. An employer match is an amount the company contributes to the employee’s retirement account, typically matching a percentage of the employee’s own contributions.
These can either be immediately vested or part of a vesting schedule based on how you, the employer, decide to provide the match. If you’re managing 401(k) benefits, you can expect to do an upload with each payroll to your 401(k) plan provider or integrate this with your payroll.
What is 401(k) Plan Testing?
401(k) plans are subject to government tests to help ensure the plan is serving the best interest of employees. The IRS wants to ensure that non-highly compensated employees (NHCEs) are benefiting from the plan, and that highly compensated employees (HCEs) aren’t unfairly benefiting from the plan.
To stay compliant with the IRS, a plan sponsor must submit an annual end-of-year checklist and fill out the form 5500 to complete plan testing. 401(k) providers can provide signature-ready forms to review and file each year.
Got questions? We have the answers! Contact a retirement plan specialist to review your options for a 401(k).
What Types of 401(k)s Are There?
ShareBuilder 401k offers four core types of 401(k) plans. Each provides flexibility for employers to meet their business needs while following required regulations.
| Solo 401(k) | Safe Harbor 401(k) | Traditional 401(k) | Tiered Profit Sharing 401(k) | |
|---|---|---|---|---|
| Best for... | ||||
| Matching is... | ||||
| Is profit sharing available? | ||||
| IRS testing is... | ||||
| Vesting schedule is... |
Solo 401(k)
A Solo 401(k) plan is for self-employed individuals or owner-only businesses without any employees (e.g. two partners own a business but have no other employees). Solo 401(k)s allow the self-employed to contribute a maximum amount of $72,000 for 2026 (or $80,000 if aged 50 or older), which is much higher than an IRA, which only allows $7,500 to be saved in 2026.
A Solo 401(k) business owner may contribute as either an employee, the employer, or both. As an employee, the owner may contribute up to the maximum employee contribution limit of $24,500 for 2026 ($32,500 if aged 50 or older).
By making employer contributions, a business owner can contribute an additional $47,500 to their 401(k), allowing them to reach the maximum annual contribution limit.
Maximizing contributions to a Solo 401(k) may offer meaningful tax advantages. By reducing taxable income, these contributions can help lower current-year personal taxes and may even place the business owner in a lower tax bracket.
Safe Harbor 401(k)
A Safe Harbor 401(k) helps maximize savings and simplifies plan management for a business. Safe Harbor plans automatically satisfy the requirements of IRS plan testing without all the hassle.
By providing a “Safe Harbor” match that is fully vested right away to all employees who participate (including the owner), employers make sure everyone can contribute up to their yearly limit.
Most employers choose to match 3% or 4% of an employee’s salary. These matching contributions are tax deductible for the business.
If a small business with fewer than 50 employees is starting its first 401(k), it may qualify for tax credits that help cover matching costs during the first three years. These tax credits make it easier for businesses to determine how to offer competitive retirement benefits while managing overall costs.
Traditional 401(k)
A Traditional 401(k) plan offers added flexibility in plan features. Not only can businesses choose whether or not to offer 401(k) matching, but they are also able to establish vesting and/or eligibility rules to retain and reward loyal associates.
Traditional plans can be a smart option for businesses that have highly seasonal cash flows and/or labor, experience relatively high employee turnover, or need the flexibility to leverage a different match amount than a Safe Harbor requires.
The ability to add multi-year vesting schedules can also make these plans a valuable tool for employee retention, especially in high turnover industries. In addition, eligibility rules can simplify administration and plan costs for businesses with seasonal employees.
Plan testing can become an issue when employees contribute much less than management. This can limit how much highly compensated employees are allowed to contribute, sometimes well below the $24,500 limit. One way to help fix this is by using automatic enrollment with a higher starting rate, like 5% or more. This encourages more employees to save and can reduce testing issues.
Tiered Profit Sharing 401(k)
Tiered Profit Sharing (also known as Advanced Profit Sharing) allows companies to define distinct employee groups and allocate different shares of profits to each group. While all types of 401(k) plans can include profit sharing, Tiered Profit Sharing offers an added layer of flexibility and customization.
In a standard profit sharing plan, the employer gives the same percentage to every employee. A Tiered Profit Sharing plan allows the employer to give different percentages or amounts to different employees. To meet IRS testing rules, these plans may need Safe Harbor contributions or other special plan features.
For example, a manufacturing company might have separate groups for management, sales, and production employees. Each group can receive a different profit sharing allocation within the 401(k), helping align compensation with each group’s role and impact on the company’s success.
Profit sharing for all 401(k) plan types are tax-deductible for the business.
To learn more about how a 401(k) with profit sharing could work for your business, contact a retirement plan specialist to discuss your options.
Which 401(k) Plan is Best for Your Business?
To determine which 401(k) is best for your business, it is a good idea to go through the different plan designs and compare them to your needs.
If you are a self-employed business owner, your best option is a Solo 401(k) if you feel like you will contribute more than $7,500 a year to your retirement. Otherwise, an IRA is a good place to start.
If your business has employees, you'll need to consider whether to offer a 401(k) match, set certain vesting schedules or eligibility rules, or determine if you need to give different employer contributions to employees based on specific criteria.
Whatever the case may be, there is no better time than now to consider your and your business’s needs when it comes to benefits, taxes, and preparing for retirement. Explore your 401(k) options and see what makes the most sense for you.
FAQs
What is a 401(k)?
A 401(k) is an employer-sponsored retirement savings plan that allows employees and business owners to contribute a portion of their income toward retirement. Contributions are invested and grow over time, often with tax advantages such as tax-deferred or tax-free growth, depending on the type of 401(k).
Why is it called 401(k)?
It’s called 401(k) because the plan is defined under Section 401, paragraph (k) of the U.S. Internal Revenue Code. This section outlines the rules governing cash or deferred arrangements that allow employees to defer a portion of their compensation into retirement savings.
How does a 401(k) work?
A 401(k) works by allowing employees to contribute a percentage or dollar amount from each paycheck into a retirement account. Those contributions are invested in funds selected by the participant. Employers may also contribute through matching or profit-sharing. 401(k) contributions are typically made pre-tax, while Roth 401(k) contributions are made after-tax.
Are employer matching contributions required?
No, employer matching contributions are optional, and businesses can choose whether or not to offer a match based on their budget and benefits strategy.
What type of 401(k) is best for a small business?
The best 401(k) for a small business depends on factors like business size, cash flow, and desired flexibility. Self-employed individuals often benefit from a Solo 401(k), while businesses with employees may choose a Safe Harbor 401(k), Traditional 401(k), or a Tiered Profit Sharing plan. Each option offers different levels of flexibility, contribution requirements, and tax benefits.