Are you considering a 401(k) plan for your Seattle small business? This is the complete guide for you to make the most of your small business 401(k) plan.
First, let’s start with the basics and define our term.
A 401(k) is a retirement savings plan that’s sponsored by an employer. In a 401(k), employees can invest a part of their paycheck before taxes are taken out, and taxes are only paid when money is withdrawn from the account.
401(k)s offer control over how money is invested. Many offer a selection of mutual funds built of stocks, bonds, and money market investments. Typically, because 401(k)s are retirement accounts, selections are designed to become more conservative as the targeted date for retirement approaches.
For employees, 401(k)s are particularly appealing because employers contribute a matching amount to the plan. A 2% match, for example, means that an employer will match up to 2% of an employee’s salary in 401(k) contributions. This approach makes it easier for employees to accumulate wealth inside of the plan more quickly.
Next, let’s clarify the distinctions between a few of the most commonly-compared retirement savings options.
An IRA, or an individual retirement account, is another type of savings account that can be used to make investments. The biggest difference between an IRA and a 401(k) is that IRAs are most commonly opened by individuals, and typically aren’t provided as employee benefits. Obviously, in these cases, there is no matching on deposits.
A Roth IRA functions similarly to a traditional IRA, but instead of contributions being made with pre-tax dollars, Roth IRAs are funded through after-tax contributions. Then, on withdrawal, distributions are tax-free.
Finally, 403(b)s are similar to 401(k)s, but are intended for nonprofit organizations, religious groups, school districts, and government organizations and generally require fewer administrative costs.
Out of all of these options, 401(k)s are nearly always the best choice for Seattle small businesses. If you’re a nonprofit, 403(b)s are the way to go.
Target date funds employ a “sliding” risk scale that becomes more conservative over time. The evolving combination of asset classes is designed to help the average investor manage risk and optimize their 401(k) as retirement approaches.
In addition to retirement planning, target date funds can also be used for other types of investment priorities that are set aside to help with anticipated expenses, such as higher education. No matter how they’re being used, target date funds all rely on the same principle of graduated risk reduction as the fund nears the target date.
There are advantages and disadvantages to target date funds, which you can learn about in our blog post.
The most obvious benefit to 401(k)s for individual employees is employer matching; essentially, employees get “free” money for depositing into their 401(k) account. Again, this is the biggest reason Seattle workers gravitate toward these accounts.
Additionally, though, depositing into 401(k)s can offer tax breaks. Employees receive the benefit of a tax deduction each time they make a contribution with pre-tax dollars – because contributions come out prior to taxes, they aren’t included in taxable income for the year.
Finally, taxes on 401(k) earnings aren’t payable until withdrawal, unlike within standard savings accounts.
While they’re great plans, there are limits to how much can be contributed into a 401(k). These are federal limits and so apply to Seattle (as well as to the rest of the country.
In 2019, the standard employee contribution limit is $19,000, although participants over the age of 50 may make an additional $6,000 in contributions for a possible total of $25,000.
In combination with employer contributions, the total standard limit is $56,000 in 2019; for participants over the age of 50, the total limit is $62,000.
These limits are reviewed annually by the IRS and are adjusted accordingly.
If 401(k) plans benefit both employees and employers, then how can you set up a 401(k) for your Seattle small business?
First, you’ll need to determine the party that will establish and maintain the plan. You can do this yourself, or you can work with a professional to guide you through the process.
Regardless of whether you choose to do it yourself or work with a professional, the next step in setting up a 401(k) plan will be to create a written plan to delineate the terms and conditions of the program. This will be a legally-binding document, so professional help is probably a good idea. It’ll include information like what type of 401(k) plan you’re offering, what features the plan will have, which employees will be eligible, how matching will work, and how funds will be collected and distributed.
With the plan documented, you’ll need to arrange a trust for the plan’s assets. This involves the selection of a trustee who will handle contributions, plan investments, and distributions to ensure that funds are only used by participants and their beneficiaries.
As the plan is made active, you’ll also need to keep records to track employee and employer contributions, earnings and losses, expenses, distributions, and investments.
Finally, you’ll need to manage employee enrollment by informing employees of the plan and its details and onboarding eligible participants.
Here’s my advice: setting up a 401(k) plan can be intimidating, and there are a lot of variables to consider. It’s almost always worth it to work with a professional to make the setup process run more seamlessly and ensure that your plan is designed in a way that best serves your business.
The most common deterrent that keeps Seattle small business owners from setting up a 401(k) plan is the cost. The good news is that, today, 401(k) plans really aren’t cost-prohibitive – I can set up a plan for a small business with 10 employees that is lower cost and higher performing than my 401(k) was 15 years ago at a Fortune 500 company.
That said, there are some costs. Typically, these can include:
- Asset-based expenses that are charged based on the amount of assets in the plan.
- Per-person expenses that are charged based upon the number of participants in the plan or eligible employees.
- Transaction-based expenses for the execution of a service or transaction.
Flat rate costs that are fixed regardless of plan factors.
Obviously, the hard cost numbers vary greatly from plan to plan and from business to business, but, with the right approach, many small businesses can afford to setup a high-quality plan. I frequently see plans that can reduce their administrative fees by $800 each year by eliminating features that aren’t used.
We’ve reviewed the benefits of individuals receive from investing in a 401(k), but for Seattle small businesses, offering a 401(k) plan also results in a variety of tangible benefits.
First, there are often tax benefits. Business owners, like employees, can deposit into their 401(k) to capitalize on tax deductions. And businesses often qualify for additional tax benefits when starting a plan – for example, there’s a fairly-common tax credit of $500 for businesses with under 100 employees for the first three years of a plan.
Secondly, offering a 401(k) plan helps small businesses to compete on the employment market with appealing benefits packages. A small business without a retirement plan is, unfortunately, less-appealing to work for (especially in the long-term) than a similar business with a retirement plan.
The bottom line is that offering a 401(k) plan can help small businesses to attract and retain top talent.
The Seattle small businesses that set up and sponsor a 401(k) plan do take on a set of responsibilities that are outlined by the IRS.
Importantly, sponsors are responsible for keeping plans in compliance. Compliance management may involve reviewing a plan’s written construction, its administration, or making necessary adjustments due to updated terms and laws.
In support of this, the IRS highly recommends frequent communication with plan service providers and administrators.
The investment committee meeting is a time for the plan sponsor (i.e., the company or organization responsible for selecting a plan, determining plan eligibility, and sometimes making matching contributions) to provide a performance overview, review plan operations, recommend changes, and address concerns from committee members.
Plan sponsors that have partnered with a financial advisor for their 401(k) plans will often find the plan’s financial advisor can help facilitate and streamline the investment committee meeting process. This usually takes the form of an annual review meeting.
Learn about some key details and logistics to plan in our blog post.
A 401(k) advisor is basically an expert who helps guide businesses in setting up, maintaining, and getting the most out of a 401(k) plan. In other words, advisors organize, formalize, monitor, and implement 401(k) plans for small businesses to help them get the results they deserve.This is what I do at Sapling Wealth Management.
At Sapling Wealth Management, I work closely with plan sponsors and strategic vendors to design thoughtfully structured retirement benefit plans for your small business and help you minimize fiduciary risk. Together, we take into consideration the objectives of the company and select from the myriad of choices available in a state-of-the-art 401(k) plan.
Once the plan is designed, I formalize a process to review, implement changes, and monitor performance, then I personally educate and support participants on how to make intelligent investment decisions.
While a plan sponsor is the organization ultimately responsible for the 401(k) plan, a 401(k) administrator is the party that manages its function.
Often, this is a hired organization or professional that manages the day-to-day aspects of the plan.
The 401(k) administrator will do things like restating plan documents, preparing benefits statements, assisting in processing distributions, and compliance testing.