A 401(k) is a retirement plan that is sponsored by an employer that allows employees to save pre-tax or after-tax contributions for their retirement. 401k plans have become tremendously popular and plan providers have improved dramatically over the last few years and now offer many more services such as increased investment selection, reduced administrative costs and efficient administration.
If a small business owner has W-2 employees (other than the business owner or their spouse) who work more than 1,000 hours per year then they do not qualify for an Individual 401k and must establish a traditional 401k plan for their small business. 401k plans can have custom features and BCM helps small businesses with their 401k plan design to maximize the benefits to our small business clients while maintaining compliance with the IRS rules. Below are a couple of examples.
A Safe Harbor 401k can be beneficial for small business owners who would like to contribute the salary deferral limit ($18,000 or $24,000 if age 50+), but anticipate they will fail the non-discrimination tests in a 401(k) plan. The Safe Harbor 401k plan allows owners and highly compensated employees to make the maximum salary deferral contributions to a 401k even if the other employees want to make limited or no contributions to the 401k. With a Safe Harbor 401k, the employer must make contributions to eligible employees according to one of two formulas. An employer is required to match employee contributions (100% of the participants first 3% of salary and 50% of the next 2% of salary) or make a non-elective contribution (make a contribution of 3% of salary for all eligible employees whether they contribute to the 401k or not). Each year the employer must make either the matching contributions or the non-elective contributions. The plan document will specify which contributions will be made and this information must be provided to employees before the beginning of each year.
A small business may want to add a profit sharing plan to their 401k. One type of profit sharing plan is a New Comparability Plan. If a small business owner would like to maximize the profit sharing contribution to the business owners or key employees while minimizing the contributions into the other employees they may be interested in establishing a New Comparability Plan. A New Comparability Plan is a profit sharing plan in which employees are divided into groups with each group receiving an employer contribution that is a different percentage of compensation. A small business can set up a New Comparability Plan to maximize contributions to the business owner and to benefit key employees while still satisfying IRS rules for a 401k profit sharing plan.
401k Contributions and Withdrawals
In 2015 a 401k participant can elect to defer up to 100% of their W-2 compensation up to a maximum of $18,000. 401k participants that will become age 50 or older during the calendar year January 1-December 31 are permitted to make an additional "catch-up" contribution of $6,000. The 2015 401k contribution limit is $24,000 for those age 50 or older. Employee contributions are 100% tax deductible and dividends and investment earnings grow tax-deferred until they are withdrawn.
In general, withdrawals from a 401k before age 59 ½ incur a 10% IRS penalty and are taxed as income. After age 59 ½ an employee can withdraw the money without penalty, but will pay income taxes. This is advantageous for many investors because they are able to make a contribution to their retirement plan and receive a tax deduction during their working years while in a higher tax bracket, get many years of growth in dividends and investment earnings without being taxed, and when retired and typically in a lower tax bracket, they withdraw the money as needed.
Some 401k plans have a loan provision which allows employees to take a loan. Tax free loans (up to 50% of the total 401k value with a $50,000 maximum) are permitted. Loans must be repaid according to the terms of the loan amortization schedule which is provided when a loan is initiated. Failure to repay the loan according to these terms may result in a loan default causing income taxes as well as IRS penalties.
Generally the total loan balance is due within a short time period (60 or 90 days) upon voluntary or involuntary termination of service with an employer. If the full remaining balance of the loan can't be repaid at that time, then the loan is considered defaulted which may cause taxes and IRS penalties.
401k Company Match Options
Employers are not required to make contributions on behalf of employees in a 401k plan. Although not required, many employers do make contributions called a "company match." A common employer match is a 1 for 2 match up to a maximum of 3%. For example, if an employee contributed 6% of their salary an employer would contribute 3% for the employee.
Frequently, there would be a vesting schedule on the company match. When there is a vesting schedule an employee would need to work for an employer for a specified time period or else they may receive none or only a fraction of the company match. Of course, employee contributions do not have a vesting schedule and are immediately 100% vested. A company match can reward loyal employees and frequently improves employee retention and helps to attract new employees.
401k Employee Benefits
Tax Benefits and Savings
Employee contributions are tax deductible from their federal income taxes and may be deductible from state taxes. 401k plan contributions are made by payroll deduction which is an easy, convenient way to save.
Tax Deferred Dividends and Investment Earnings Growth
Any gains from dividends or investment earnings grow tax deferred. For investors saving for their retirement this can mean many years of tax deferred growth. Tax deferral can have a powerful effect over time to increase funds available for retirement.
Within 401k plan guidelines, employees can decide how much they would like to save and can increase, decrease or even stop their contributions. If an employee changes jobs they can transfer via a 401k rollover or they can choose to transfer it to their new employer's 401k.
In many 401k plans there are between 10-20 mutual funds ranging from conservative bond mutual funds to aggressive growth stock mutual funds to accommodate investors of different ages and risk tolerances.
401k Employer Advantages
Lower Cost and Tax Savings
In general, employer costs are lower in a 401k plan compared to other types of qualified retirement plans. Employer contributions to their own account are tax deductible. In most cases, if there is a "company match", contributions on behalf of employees are also tax deductible to the business.
Employees appreciate that their employer is providing a way for them to save for their retirement. Also, when employees save for their retirement they feel more secure regarding their future and may be less inclined to change employers.
Employee Attraction and Retention
Today an employer may have to offer a 401k plan in order to compete for certain job applicants. In fact, if an employer doesn't offer a 401k it may serve as a factor for an employee not accepting one job offer and accepting another. The popularity of 401k plans is a significant factor in attracting and retaining valuable employees.
Small Business 401k Services
One of the important services we provide is to serve as objective 401k plan specialists to educate HR directors, CFO's and business owners on available 401k plans in the market place.
Small Business 401k Plan Provider Search
Once we have helped educate you regarding the possible 401k plan options for your firm and we know the criteria that is important to you, we begin our search to help you find a 401k provider best suited for your specific situation. Beacon Capital Management Advisors works with many 401k plan providers. Our search to find your ideal plan is efficient, cost effective and hassle free.
Receiving a 401k Plan Proposal
Whether your company is starting a new 401k or you have an existing plan and are looking for better administration, more investment choices, lower costs or better employee education, BCM can assist you in this process. Complete the form below to receive a 401k plan proposal.