What are Starter 401(k)s?

An Introduction to Starter Plans

This article will examine the recently introduced Starter 401(k) plan and its fundamental aspects. These plans have been made available since January 1, 2024, as an option for employers. We'll explore critical factors you should review before opting for this plan.

The House Ways and Means Committee recently passed the Secure Act 2.0, which includes various provisions to increase retirement savings. Starting January 1, 2024, small businesses can offer Starter 401(k)s.

Small Business Retirement Plan Options 

Many retirement plans are available to small companies. They each offer different options and levels of flexibility in plan design. Employers can choose from SIMPLE IRAs, SEP IRAs, and 401(k) plans.

However, small business owners often struggle with the administrative burdens and compliance costs associated with offering retirement benefits to their employees. These challenges can make it difficult for small companies to choose the right retirement plan that meets their needs and budget.

Traditional 401(k) plans stand as the most widely used option. However, despite their popularity, the perceived and actual costs of establishing and maintaining these plans and the administrative tasks involved can be a turn-off for some employers. As a result, many small companies end up foregoing this retirement plan option altogether.

The Starter 401(k) was created to address this issue and make it easier for small companies to provide a retirement plan for their employees. This plan is designed to be low-cost and easy to implement, with minimal administrative burdens. With this option, small businesses can offer employees a valuable retirement plan without breaking the bank or getting bogged down in complex administrative tasks.

How Do They Work?

Eligible employees are automatically enrolled under the Starter 401(k) plan. Employees have the chance to opt out if they choose to do so. The plan is funded entirely with employee elective deferrals at 3% to 15% of compensation.

Though the IRS generally updates retirement plan contributions annually, the maximum contribution for 2024 is up to $6,000. There is also a $1,000 catch-up contribution that can be made for those who are 50 or older. No employer contributions are allowed.

When employers establish a Starter 401(k), they may be exempt from the requirement to enroll in state-run plans for private-sector employers, provided they live in a state that mandates such plans. It is worth noting that several states have enacted this requirement, and failure to comply with this mandate can result in significant penalties for employers.

How Do Starter 401(k)s Differ from Traditional 401(k)s?

Starter 401(k)s and traditional 401(k)s have significant differences. Here are some of the major differences between the two.

Contribution Limits

There is a critical difference between the Starter 401(k) and traditional plans. The Starter 401(k) is funded solely with elective deferrals, while the traditional 401(k) allows for both employee and employer contributions. Employers can match employee contributions in traditional 401(k)s, making it an attractive employee benefit.

Additionally, the contribution limits for Starter 401(k)s are lower than those of traditional 401(k)s. Eligible employees can contribute up to $6,000, with a $1,000 catch-up if they are over 50. In comparison, the contribution limits for an IRA or Roth IRA in 2024 are $7,000, with a catch-up limit of $1,000. It's important to note that individuals can set up automatic contributions to an IRA.

On the other hand, traditional 401(k)s have a higher annual contribution limit of $23,000, with a $7,500 catch-up for those over 50. Below is a breakdown of these facts.

Traditional Plans

• $23,000 Employee Contribution Limit

• $7,500 Catch-Up Contribution

• $69,000 Total Possible Contributions (Employee and Employer)

Starter 401(k) Plans

• $6,000 Employee Contribution Limit

• $1,000 Catch-Up Contribution

Annual Compliance Testing Requirements

One of the significant benefits of Starter 401(k)s is that they do not require annual compliance testing. Unlike traditional plans, which mandate annual testing to ensure that the plan meets specific nondiscrimination requirements, Starter 401(k)s are exempt from these testing requirements.

This lack of testing requirements can save small businesses time and money. Smaller companies may deal with more testing.

Traditional Plans

• Testing Required

Starter 401(k)

• Testing Not Required

Plan Design Flexibility

In traditional 401(k)s, employers have flexible plan design. They can choose to include vesting schedules, profit-sharing contributions, and loans to participants. Traditional plans also offer the option for Roth contributions.

Starter 401(k)s have limited plan design flexibility. These plans are designed to be straightforward and easy to administer, with minimal administrative burdens. As a result, there are fewer bells and whistles available in terms of plan design.

Starter 401(k)s only allow for elective deferrals, meaning that employer contributions are not allowed. Additionally, there are no vesting schedules or profit-sharing contributions available in Starter 401(k)s. Loans are also not allowed in these plans.

Traditional Plans

• Plan Design Flexibility

  • Vesting schedules

  • Profit-sharing contributions

  • Loans

Starter 401(k)

• Limited Plan Design Flexibility

Conclusion

In short, there are several differences between Starter 401(k) plans and traditional plans. These include availability, funding sources, contribution limits, and complexity. While traditional 401(k) plans offer greater flexibility and higher contribution limits, they provide a low-cost and easy-to-implement retirement plan option for small businesses to offer their employees a way to save for their future.

Starter 401(k) plans serve as a simple and affordable alternative to some state-mandated plans. With the right provider, you may have more flexibility in investment options than with a state-mandated plan. However, not all states require such plans.

The trade-off for simplicity is a loss of flexibility. Alternatively, individuals could set up an IRA, which allows for higher contribution limits and automatic contribution scheduling.

There are several retirement plan options available to small businesses. This new option provides an additional choice to consider. If you need help deciding which retirement plan is best for you and your company, you can schedule an appointment with one of our financial advisors.

Our team of wealth management professionals and 401(k) advisors is located in the greater Salt Lake City area of Utah, but we serve clients in many states. We provide financial planning services and advise on employer sponsored retirement plans.