Sponsoring a retirement plan for employees is a big step for a small business. Here are four considerations that can help you determine whether offering a retirement plan is a good strategy for your business.
1. It helps you attract and retain talent.
As the country enjoys low unemployment rates and skilled workers are in high demand, offering a retirement plan as part of your benefits package helps you compete against larger companies to attract and keep top talent.
A recent survey of 100 companies from Callan found that 16% of employers planned to reinstate or even raise their 401(k) contributions in 2022. Another 8% were considering such a move. That represents a significant rise from 2021, so business owners shouldn’t discount the attractiveness of this benefit.
2. It gives you tax advantages.
If you haven’t offered a retirement plan before and have fewer than 100 employees, you may be eligible for the Retirement Plans Startup Costs Tax Credit. For the first three years of your plan, you’re credited up to 50% of plan startup and administration costs, up to $500 per year. If you match your employees’ contributions, your contributions are tax-deductible. You may also be able to lower your personal income tax bracket by participating in the plan. You should consult your certified public accountant (CPA) or tax advisor about the tax implications for your business as well as your personal finances.
Upcoming federal legislation may offer additional tax credits to small businesses that automatically enroll their employees in a retirement plan. It may ease other regulations as well, making it easier for small business owners to offer this benefit to their employees.
3. It helps you save for your own retirement.
You’re allowed to participate in the plan you sponsor, and you’ll be able to save more money for retirement than if you set up a traditional or Roth IRA. Many small business owners choose the safe harbor 401(k) because it allows them to max out their own retirement contributions when they match or contribute to employee accounts. Again, you should ask your CPA or financial advisor how you can maximize your retirement savings under the plan you select for your business.
4. Your state may require it.
Some states have passed, or are in the process of passing, legislation that requires businesses to either provide retirement plans for their employees or register with the state and allow their employees to participate in a state-sponsored plan. Employers choosing the latter would be required to submit employee payroll contributions to the state, but as of this writing, they wouldn’t be required (or allowed) to contribute to employee plans. They would, however, face penalties for noncompliance. They also wouldn’t receive the tax credits for sponsoring a plan of their own.
California, Illinois and Oregon have already begun implementing such legislation in phases, starting with larger businesses. Small businesses will also be subject to this legislation. As of June 2022, California now requires businesses with five or more employees to enroll in CalSavers, a state-sponsored retirement savings program. In this case, employers don’t pay fees and have minimal responsibility. However, failure to allow employees to participate can result in a fine of up to $750 per employee.
Connecticut, Maryland and Massachusetts have passed legislation to form state-run plans. New Jersey and Washington plan to offer online marketplaces where small business owners can shop for retirement plans for their businesses.
Costs depend on how many employees participate in the plan, the type of plan you choose and the retirement plan company (or companies) that help you run the plan. You should also consider whether you will match or contribute to your employees’ IRA or 401(k) accounts.
For 2023, employees can contribute up to $22,500. Employees age 50 and older can make an additional $7,500 catch-up contribution. Employers’ contributions cannot exceed 25% of an employee’s compensation. For 2023, employees and employers can contribute a total of $66,000.
Note that this differs for small business owners with no employees other than a spouse. Sole practitioners can set up a self-employed 401(k) with a $22,500 annual contribution limit as of 2023. Similar to businesses with multiple employees, the total employee and employer contributions cannot exceed $66,000.
You should approach setting up a 401(k) the same way you would implement health insurance or other benefits for your employees. That means conducting research, figuring out what your employees want and making decisions based on your due diligence. Once you settle on a retirement service provider, you have to choose the plan that works for your business, budget and employees’ needs.
Armed with your research, you next have to create a plan document that meets IRS requirements and details the important aspects of the plan. You also have to choose a trustee to handle the plan’s contributions, plan investments and distributions. Under IRS rules, the plan’s assets must be held in trust to ensure funds are used to benefit plan participants and their beneficiaries. It’s also important to keep detailed records of your employees’ contributions and the current performance and value of the plan. You can outsource those tasks to a 401(k) recordkeeper if you don’t hire a provider that does it all for you.
It’s also incumbent on you as the employer to provide information about the plan to your participants, such as alerting them to any investment changes or if fees are raised or lowered.
Small business owners have many options for retirement plans to offer employees. The two main types are 401(k) plans and IRA, each with various options and subtypes.
A 401(k) is the most popular type of retirement plan for employers to offer by far. It’s attractive because of its high contribution limits for employees and choice of pretax or Roth contributions. Business owners can choose a traditional 401(k), a safe harbor 401(k) or an individual 401(k) plan.
IRA plans are easier and cheaper to set up and maintain, but they have lower contribution limits for employees than a 401(k) plan. There are Roth IRAs, SIMPLE IRAs and SEP IRAs. Employees can access employer-sponsored IRAs and personal IRAs to supplement workplace-sponsored retirement plans.
Since the SECURE Act of 2019, small businesses can join with other businesses to participate in a 401(k) plan. A pooled employer plan (PEP) is designed to lower the cost of offering an employee retirement plan and get more businesses to offer it to their workforces. The PEP is administered by the plan provider, which serves as both sponsor and formal plan administrator. That’s attractive to small business owners who don’t want to worry about the fiduciary and administrative requirements associated with employee retirement plans.