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Pros and Cons of 401(k)s for Startups

By Barbara A. Friedberg

Imagine you’re in on the ground floor of the next Google or Facebook. Who needs a 401(k) when you’re going to be a billionaire, or at least a multi-millionaire soon? If this is what you’re thinking, you may want to reconsider.

As the following graphic illustrates, startups have a high failure rate.

Startup Success Rates – After 4 Years

startup failures static brain

Depending upon your industry, your startup has varying possibilities of success after 4 years. Additionally, even if the company is still in business at the 4-year point, there’s no guarantee the business is approaching profitability or that it will endure over the long haul. Your future as a future startup millionaire may not be certain.

Characteristics of a Startup

Before we examine the pros and cons of 401(k)s for startups, let’s look at why you can’t evaluate a startup in the same way you would for a typical “small business”. Then we’ll explore how these factors influence the pros and cons of 401(k)s particularly for startups.

  • Typical workers at startups are younger than at more established firms.
  • Although startups may have venture capital funding, they’re rarely profitable.
  • In many cases, startups offer higher than average salaries.
  • Many startups are located in high cost of living areas such as San Francisco, Silicon Valley, and New York City.
  • Salaries may include commissions, stock options and other types of compensation.
  • Startups don’t normally have developed human resources (HR) departments and may lack knowledge about and experience with the breadth of HR topics (compensation, benefits, compliance, etc.)
  • Startup investors want to see results and short-term business growth; not long-term employee benefit packages.

Pros of 401(k)s for Startups

Founders and startup employees are typically more focused on investing company capital in growing quickly and exponentially, and less interested in “long-term investments” like 401(k)s for their employees. However, there are both short-term and long-term benefits to setting up (for employers) and participating in (for employees) a 401(k).

Employee recruitment and retention: Research supports the adoption of a 401(k) as a clear recruitment and retention tool. The employment market for technology, computer and engineering professionals is competitive, particularly in major startup hub cities such as NYC and SF. These types of professionals have their pick of jobs, so adding additional benefits can help startup employers stand out from the pack to hire and retain top employees.

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Long-term financial benefits for employees: Even employees who are focused on paying their rent and living expenses today may be enticed by a robust 401(k) program if they learn about the long term benefits. Should the company fail, the opportunity to walk away with thousands of dollars in a 401(k) plan is a strong safety net for the employee.

Tax breaks for the company: Money is especially important for startups, especially if the firm is not yet profitable. Tax breaks make starting a 401(k) for a startup more feasible. Employers may qualify for a tax break for offering their first 401(k) plan. IRS form 8881 outlines the tax credit for startup employers.

High ROI benefit/perk: If you’re looking for a benefit that has a high “bang for your buck”, a 401(k) plan for your entire company can cost less than half of a single person’s health insurance or a ping pong table, and matching is not required.

Employers’ fears about setting up a 401(k) are largely unfounded. Today there are a variety of low-fee, low-maintenance, tech-enabled 401(k) options for an employer. Employers would benefit from comparing the benefits of setting up a 401(k) with the costs. It may be a surprise to find out how easy 401(k) set up is.

Cons of 401(k)s for Startups

Some of the pros for 401(k)s for startups may also viewed as cons!

Lack of financial literacy/lack of employee interest: Many startup employees are young and living in high cost of living areas, and therefore may not appreciate the value of a 401(k). Jackson, the 28-year-old software developer, may just not have had an experience with a 401(k) previously, or simply no interest in one. Jackson figures that if the company goes under, he’ll just get another job, likely at an even higher salary. Or, he may have expensive rent and student loans, and may not be prioritizing retirement and his long-term financial security at all.

Startup founders and employees are busy: In many cases, the management (the founder, the CEO, the COO, the office manager — whoever is in charge of managing the 401(k)) is wearing many hats; gaining funding, implementing and fine-tuning the product, marketing the company, and managing customers. Without an HR department, the startup founders may not see the value in creating, maintaining, and ensuring IRS compliance for a 401(k) for the company.

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Cost of a 401(k): Many startup employers believe they can’t afford to pay for a 401(k) plan. Couple that idea with the belief that the plan doesn’t matter to employees, and this task item will consistently fall to the bottom of the priority list. Additionally, employers may lack knowledge and information about the availability of affordable 401(k) plans, and so starting the research to see what options they have can seem daunting.

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Is a 401(k) worthwhile for startups?

  • With the advance in affordable 401(k) options for employers, there’s generally no reason not to set up a 401(k) for a startup.
  • A few exceptions: If you have major cash flow concerns, or you don’t yet offer health insurance, these should be higher priority than a 401(k).
  • If a company wants to grow beyond the startup stage, and develop into a scalable business, then attracting top talent and keeping the employees happy and productive should be a primary concern. A 401(k) can serve as an attractive part of a compensation package.
  • Employers and employees will be happier if Jackson and his cohort understand how a few dollars per month into a 401(k) today can yield a relaxing and profitable retirement tomorrow. Younger employees will benefit significantly by creating a sound retirement fund as early as possible. Without the former cushion of defined benefit pension plans, today’s workers and employers need to prioritize their own retirement futures in a way their parents and grandparents may not have had to.
  • The administrative burden for companies to manage a 401(k) doesn’t have to be high — look for a provider, like Human Interest, that has a lot of expertise when it comes to 401(k)s for the startup demographic and can manage the setup and maintenance of the plan entirely.

Human Interest works with startups like Joyable and Buffer to help their employees save with a great, scalable 401(k). Click here to learn more.