× Freshbooks App Logo
FreshBooks
Official App
Free - Google Play
Get it
7 Min. Read

How to Start a 401k for My Small Business: 5 Easy Steps

To set up a 401k for your small business, just follow these five easy steps.

  1. Determine Type of 401k Plan
  2. Determine a 401k Provider
  3. Determine a Trustee for Your Small Business’s 401k
  4. Adjust Your Accounting Processes to Include 401k Deductions
  5. Make Your 401k Policy

1. Determine Type of 401k Plan

There are many different types of 401k plans available for you to consider for your small business. They are:

Traditional 401k Plan

A traditional plan allows an employee a range of investments to choose from. Money is taken directly from the employee’s paycheck and deposited into the 401k without going through the employee first. Some companies will also add a contribution too, typically the amount the company invests is based on how much the employee contributes.

Safe Harbor 401k Plan

This is the same as a “Traditional 401k” except that the company’s contribution is mandatory. Some businesses prefer this option as it allows them to get out of the required government testing that ensures all employees are being treated equally under their particular 401k plan.

Simple 401k Plan

This is a simplified plan, sometimes considered attractive for small businesses because it requires less administration. Companies must have fewer than 100 employees to be considered for it. The employer must match up to 3% of each employee’s pay, or make a non-elective contribution of 2% (“non-elective” is contributions made even if the employee does not contribute).

Solo 401k Plan

This is designed specifically for a small business owner who has no employees other than his/her spouse.

Roth 401k Plan

The Roth 401k plan allows employees to contribute money they’ve already paid tax on, in addition to a regular 401k contribution that is made pre-tax. This means in their retirement years they will not have to pay tax on the Roth portion when they withdraw it (because they already have).

2. Determine a 401k Provider

Determining a 401k provider may not be as difficult as it sounds. You may be thinking of reaching out to various financial institutions for their advice but consider first what you’re looking for in a provider and ask these questions:

  • What’s Your Investment Lineup Like? How many funds do you offer? How diversified is the portfolio and how well has it done previously? Best to ask these tough questions now, and see how the answers stack up to their competitors.
  • What Are the Total Fees? Perhaps the funds the institution you are considering look attractive. But how much will the investing, record keeping and administration expenses cost you and your employees? Are there any surprise service fees or occasional costs that if you don’t ask about now you’ll only find out about later? Great returns could be offset by heavy fees. Ask exactly what this is going to cost from month to month.
  • How Easy Is the Administration of the Plan? How easy will this plan be to administer to your employees? Will it require a lot of day to day management or will it practically run itself? Will your employees be able to access their plans online? What digital tools will the institution offer that will help you and your employees get the information they need, or navigate the site?

3. Determine a Trustee for Your Small Business’s 401k

Okay, so now you have the plan but you need to designate a trustee to ensure the money gets to your employees (or their beneficiaries). You will be responsible for designating the trustee, but the trustee will control the assets of the plan, and report back regularly to you or to your management team.

4. Adjust Your Accounting Processes to Include 401k Deductions

Now, along with other regular accounting duties, your accountant must ensure that the 401K contributions from both employer and employee are transferred and properly accounted for. These amounts will be different for everyone, so take some time to ensure a proper process is put in place.

5. Make Your 401k Policy

Put it in writing. Announce the introduction of the 401k policy to your staff. Outline who can contribute, when they can enroll, and how much the employer contributions will be. Answer the common questions about the tax implications and when the contributions will become vested (that’s when the company’s contributions become theirs). You’ll also be asked about fees and when they can withdraw their money, so have those answers in there.

Other Questions Related to How to Start a 401k for My Small Business:

What Does a 401k Do?

What Is a 401k Retirement Plan?

What Does a 401k Do?

A 401k allows employees of companies in the United States to save money in a defined contribution retirement account that is tax deferred. This deferral is an incentive for people to save so they will have an income stream upon retirement. Typically, any income contributed to a 401k in a given year will not be subjected to tax in that same year (although a Roth 401k, as outlined above, works differently).

The IRS places limits on individual contributions every year, although the United States government allows for top ups in certain situations if you are over the age of 50.

The money will only be taxable when it is removed from the account.

The 401K was introduced in 1978 and the name refers to the section of code assigned to it – Section 401(k). Plans similar to that of a 401k exist in other countries. In Australia, the program is called “Superannuation”, in Canada it is referred to as an “RRSP” (Registered Retirement Savings Plan) and in Japan it is called “iDeCo”.

What Is a 401k Retirement Plan?

A 401k retirement plan is a retirement savings plan or fund sponsored by a business. Typically, an employer will withhold a certain amount of an employee’s pay, add to it, and then transfer it into a 401k in the employee’s name.

Many companies offer a 401K retirement plan as part of their overall benefits package. This is designed to attract top talent and to keep them. Let’s give an example of how this could work.

Jimmy’s Juice, located in a suburb of Chicago, is a fruit juice manufacturer. Although not a huge company, profits have been steadily increasing since it opened for business three years earlier. Back then, Jimmy Johnson, the company’s owner, could not offer much for his employees in the way of benefits except what was mandated by law. Recently he introduced a 401k plan for his employees.

Sarah Thompson works for Jimmy. Her salary is $60,000 per year. She contributes a certain percentage of her paycheck to this new 401k plan. The payroll department at Jimmy’s company routes this money directly into an account they’ve opened in Sarah’s name, meaning deposits into it will never actually pass through Sarah’s hands.

Sarah’s contributions equal $8,000 over the course of the year. The IRS now looks at Sarah’s gross income for the year as $52,000, not $60,000. For this reason, less tax has been taken off her regular biweekly paycheck.

There are also her employer’s contributions to the 401k. They will grow with Sarah’s contributions, and like the principal amount she invested, she will not pay taxes on this income until she starts spending the money in retirement.

RELATED ARTICLES

Save time Billing and Get Paid 2x Faster with FreshBooks

Try FreshBooks Free