Human Interest - The 401(k) provider for small and medium-sized businesses

401(k) Basics for Employers

By Liz Sheffield -

A 401(k) is one of the most common retirement investment options offered by employers in the United States today. It’s not surprising why. These plans provide both employers and employees with a flexible way to save money for retirement, and they have been around for almost 40 years.

At Human Interest, we offer 401(k) plans for startups and small businesses. However, if you’re an employer who hasn’t offered a 401(k) benefit before — or even if you have — it’s important to understand the 401(k) basics for employers before you decide on the plan that’s right for your organization. Consider this your complete beginner’s guide to 401(k)s.

What is a 401(k) plan, and how does it work?

A 401(k) is an investment plan that allows employees to contribute a percentage of their salary to a designated retirement account. Contributions to the 401(k) are invested in a portfolio made up of mutual funds, stocks, bonds, money market funds, savings accounts, and other investment options. These deferred contributions are usually taxable only when the employee makes a withdrawal: typically at retirement. 401(k) plans offer a good way for employees to save money for their futures, and for both employers and employees to save on taxes

In 2019, individuals may contribute up to $19,000 (or $25,000 for individuals over 50 years old). In 2020, individuals can contribute up to $19,500 (or a total of $26,000 if they are over 50 years old). The IRS can establish new 401(k) and IRA contribution limits every year. However, employer contributions are not considered against this annual cap.

RELATED: How does it stack up against similar options? Learn the IRA, 403(b), and 401(k) basics: 401(k) vs. 403b vs. Solo 401(k) vs. Simple IRA vs. SEP IRA

What is the standard 401(k) employer contribution?

Unlike a pension, employers are not obliged to make contributions to employees’ 401(k) retirement accounts. This flexibility makes the overall costs much more manageable. While it isn’t required, many employers choose to match 401(k) contributions up to a certain percentage or make contributions based on a profit-sharing arrangement as an added benefit for their employees. Employers can also match up to a set dollar amount to limit their contribution obligation toward highly compensated employees. These matching funds can be modified or eliminated based on the employer’s discretion.

For example, an employer might match 100% of an employee’s 401(k) contributions up to 4% of their total compensation. If the employee makes $100,000, their employer will contribute up to $4,000 to their 401(k) account. However, the employee can only realize that $4,000 if they contribute $4,000 themselves. It’s much more common for employers to set partial matching schemes of 50% than full matching.

401(k) benefits for employers

One of the primary reasons companies offer 401(k) plans is to attract and retain top talent at every level of the organization. A 401(k) is attractive to employees because it provides an easy, cost-effective way to plan for retirement by making tax-deferred contributions to an investment fund. But employees aren’t the only ones who receive tax benefits from a 401(k) plan—employers can also deduct contributions made to employees’ 401(k) accounts. For the first three years of having a plan, businesses may be eligible for a $500 annual business tax credit.

Benefits of contributing to a 401(k) include:

What are the requirements of a 401(k) plan?

The IRS has requires that a 401(k) plan satisfy a whole host of criteria, including but not limited to:

At Human Interest, we offer automated 401(k) non-discrimination testing (NDT).

What is a vesting schedule?

A vesting schedule establishes what percentage of the employer contributions an employee owns over time. Many employers that offer matching schemes incentivize longer-term employment by offering partial ownership over time. 

There are three general types of vesting schedules:

  1. Immediate Vesting: Employees own 100% of the employer matching contributions immediately.
  2. Graded Vesting: Employees own a growing percentage of the employer 401 (k) contributions over time. For example, an employee may own 25% of an employer’s matching contributions after one year of employment, 50% after two years, and so on. Employers must vest employees at least 20% of the contributions by the end of two years and 100% by the end of six years.
  3. Cliff Vesting: Under this schedule, employers must fully vest their employees by the end of three years of employment, and there are no progressive levels of vesting.

Vesting schedules must be clearly explained in the employer’s 401(k) plan document.

What 401(k) administration services are available?

Financial institutions and retirement plan professionals are available to help organizations manage 401(k) plan administration. Even if you hire an outside group, your company must ensure responsible management of the 401(k) plan. When interviewing investment administrators, ask for details about the services they offer and the compensation they receive from both you (the employer), the employees, and any third parties.

You’ll want to understand the firm’s financial situation, their business practices, and details about the quality of the services they provide (e.g., who will handle the plan’s account, their performance record, any legal action, etc.). Do they offer both Roth and traditional 401(k)s? How do they handle rollovers? Will they help you decide whether to offer loans and hardship withdrawals as an option for your employees? Once you’ve made your decision, it’s important to continue reviewing documents, reports, and service level agreements with your provider. As an employer, you must be diligent about protecting the investments you and your employees make.

Where should you begin with your 401(k)?

Now that you have some basic information about 401(k)s under your belt, the next step is to consult your financial, tax, and legal advisors regarding your company’s retirement benefits. These experts will be able to identify rules and requirements specific to your organization. As you work through the process, keep these tips in mind:

Is Human Interest a good fit for your 401(k) plan?

If you agree with any of the statements above, Human Interest would be a great fit for your organization. Click here to request a free consultation with us.

Avatar Liz Sheffield

Liz Sheffield has more than a decade of experience working in HR. Her areas of expertise are in training and development, leadership development, ethics, and compliance.

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