What Is a 401(k) Plan?
Overview
Retirement plans are vital to a robust employee benefit plan in the competitive employment landscape. You can offer a competitive job with excellent perks. But, if you can't compete with a robust employer-sponsored retirement plan, your company will be vulnerable to losing employees to competitors.
Retirement plans can help companies hire and maintain top talent. One of the most popular options for employer-sponsored retirement plans is the 401(k).
If you're a business owner, HR professional, or executive, understanding the ins and outs of a 401(k) plan can significantly impact employee satisfaction and your overall business competitiveness. This guide explores everything you need to know about 401(k) basics, including their benefits, setup process, and compliance essentials.
What Is a 401(k), and Why Is It Important?
Employers offer 401(k) plans as retirement savings accounts. These plans allow employees to contribute a portion of their paycheck to a retirement account in their name, often with additional contributions or matches from the employer. Named after the Internal Revenue Code section that created them, a 401(k) provides a reliable way for individuals to grow their savings and prepare for retirement. Contributions to the retirement plan are made directly through the employee's payroll, making retirement savings simple and accessible.
How a 401(k) Works
For Employees
Paycheck Contributions: Employees can contribute pre-tax or post-tax (Roth) dollars from their paychecks to a 401(k) account.
Investment Growth: Contributions are invested in various options, such as mutual funds, stocks, or bonds, allowing savings to grow over time.
Tax Advantages: Traditional 401(k)s defer taxes until withdrawal, while Roth 401(k)s offer tax-free withdrawals in retirement.
For Employers
Employer Matching: Businesses often match employee contributions to a specified percentage or dollar amount, boosting employee savings.
Tax Benefits: Employer contributions are tax-deductible, offering financial advantages for the business.
Benefits of a 401(k)
For Employees
Tax Incentives: Pre-tax contributions reduce taxable income, while Roth contributions grow tax-free.
Compounding Growth: The earlier employees contribute, the more significant the long-term growth thanks to compounding interest.
Financial Security: A 401(k) helps provide a sense of security by ensuring a reliable stream of income during retirement.
For Employers
Employee Retention: A competitive 401(k) plan helps attract and retain skilled professionals.
Improved Morale: Employees value employers who invest in their financial future, boosting job satisfaction and productivity.
Tax Savings: Matching contributions and administrative costs are tax-deductible.
Types of 401(k): Traditional vs. Roth
Traditional 401(k)
Contributions are made pre-tax, reducing taxable income.
Taxes are paid upon withdrawal during retirement.
Ideal for employees expecting a lower tax bracket in retirement.
Roth 401(k)
Contributions are made post-tax, with no taxes on qualified withdrawals.
It is ideal for employees expecting a higher tax bracket in retirement.
Offering both options allows employees to choose what aligns with their financial goals.
Employer Contributions and Limits
Employer Matching
An employer match is not required unless you set it up this way through the plan documents. However, matching contributions show employees that you value their long-term financial well-being. Making an employer contribution is a great way to remain competitive and provide another reason for employees to stay with your company.
As 401(k) advisors, we work with Human Resources and executive management to see how competitors in a company's industry compare. In some industries, providing a match is more common than in others, and some industries are more likely to contribute more generously.
Contribution Limits
Employee Contributions: For 2025, employees can contribute up to $23,500 annually ($31,000 for those aged 50+).
Employer Contributions: Combined employee and employer contributions cannot exceed $70,000 ($77,500 for those aged 50+).
Understanding these limits ensures compliance and maximizes potential benefits for employees and your business.
Setting Up a 401(k)
Implementing a 401(k) plan requires thoughtful planning. Utilizing the help of a 401(k) advisor is helpful. Here's how to get started:
Evaluate Your Needs
Assess your business budget to determine the level of employer matching contributions and plan administration costs you can afford. There are many ways to design a plan; some are easier on the budget than others. For example, if everyone is eligible from the start and you provide a match, you must budget more than if you have no employer match or require a year of service.
Choose a Plan Type
Select a plan that best suits your business goals. A Safe Harbor 401(k) provides a pass on some of the non-discrimination testing. This can be helpful for small business 401(k) plans with a large gap between rank-and-file employees and high-income earners.
Select a 401(k) Provider
Partner with a trusted 401(k) advisor who can guide you through the setup and management process. Our team of wealth advisors in Utah is experienced in retirement plan setup. Though our main office is in Utah, we service plans nationwide.
Design the Plan
Customize plan features, including eligibility requirements, vesting schedules for employer contributions, and investment options. This is another step in which a qualified retirement plan professional can add value. Plan design offers a lot of flexibility, but once you decide how your plan functions, following the legal documents governing it is imperative.
Educate Employees
Provide employees with educational resources and informational sessions to help them make informed decisions about their contributions and investment options. We have found that the education provided to participants influences the plan's success.
If management is involved in marketing the plan and scheduling information sessions about the plan, employees are more inclined to participate. Employees look to management to understand the importance of saving for retirement and participating in the employee benefits they offer.
Launch and Monitor
Roll out the plan, then periodically review its performance and participation rates to make necessary improvements. One of the most common issues we find is that employers neglect to review their 401(k) plans after they launch them. As your plan grows, it is essential to periodically gather proposals from providers (RFPs) to ensure the plan's costs remain competitive.
Key Compliance Regulations
Maintaining compliance is crucial for avoiding penalties and ensuring the success of your 401(k) plan.
ERISA Guidelines: Adhere to the Employee Retirement Income Security Act of 1974, which sets minimum standards for retirement plans. Look for the right professionals to help you adhere to the ERISA requirements.
Annual Testing: Non-discrimination testing ensures the plan benefits all employees fairly. This is where a Third-Party Administrator (TPA) comes in handy. TPAs generally perform annual testing to help the plan fiduciaries understand how to stay compliant.
Fiduciary Responsibility: Employers must act in the best interest of employees when managing the plan. Several options exist to provide fiduciary training and help you know your responsibilities.
Form 5500 Filing: Annual reporting to the IRS is required to maintain compliance. For small employers, this is simple to complete. Large companies often require a third-party audit.
Staying current with regulations protects your business and ensures that employees enjoy the full benefits of their 401(k).
Make Retirement Planning a Priority
Offering a 401(k) plan is more than just a benefit; it's a strategic investment in your business's future. With tax advantages, employee satisfaction, and recruitment benefits, a well-designed 401(k) plan provides value to both employers and employees.
Partnering with a 401(k) advisor and staying informed about compliance requirements can simplify the process. Start by evaluating your options, educating your team, and implementing a plan tailored to your business needs.
Prioritize retirement planning today and show your employees you're invested in their future. Explore your options or consult with experienced professionals like 401(k) advisors to get started.