401(k) basics for accounting professionals

As an accounting professional, you may not be too familiar with the intricacies of retirement planning. However, because you care about the financial future of your clients, you might find it useful to know the basics of 401(k) plans to help reduce their administrative and tax burdens. 

In this article, we’ll give a refresher on what a 401(k) is and the key features of common retirement plans. We’ll also cover retirement legislation and touch on the tax advantages of providing a 401(k). 

401(k) refresher

For employers, one of the primary purposes of a 401(k) is to encourage employees to build a nest egg for their retirement. Additionally, it is also one of the most sought-after benefits (right after health insurance), which can make it an effective perk to attract and retain employees. 

A traditional 401(k) allows employees to contribute a percentage of their paycheck into a 401(k) account on a pre-tax basis. Employers have the option to contribute a match and/or nonelective contribution into the participant’s account as well. 

A matching contribution is when an employer contributes to their employees’ 401(k) account based on the amount of money that an employee defers. For example, if an employee contributed $2,500 (or 5% of their salary) to their 401(k), the employer may choose to contribute $0.50 per dollar on the first 5% an employee defers, which would equal $1,250. Now, the employee has $3,750 in total contributions for the year. 

A nonelective (or profit sharing) contribution is when an employer decides to contribute a certain dollar or percentage amount to the plan. It is then allocated among eligible participants, regardless of the deferral amount.

Find out how much a 401(k) could cost your business

If a small business is interested in setting up a 401(k), it will need to have some idea of the different components in a 401(k) plan design, which include: 

1. Eligibility: Employers can set eligibility requirements to determine which employees can participate in the 401(k) plan. IRS regulations require that employees who are 21 years or older and have completed one year of service (approximately 1,000 hours of work in 12+ months) to participate in a qualified retirement plan. Employers have the option of allowing employees to participate earlier than this maximum requirement.

2. Vesting: Employers have the option to apply a vesting schedule to employer contributions. Vesting refers to the ownership an employee has over the employer contributions in their 401(k) account. If an employee is 100% vested, it means that he or she is entitled to all the funds in that employer source. Note that employee deferrals and rollovers into the plan are always 100% vested immediately. 

3. Compensation: Employers can choose to exclude certain types of compensation when calculating employee deferrals and employer contributions, subject to non-discrimination testing. 

4. Contributions: Employers have the option to make different types of contributions to their employees’ 401(k) accounts. Some of these options include employer match and profit sharing. 

5. Distribution: Employers have the option to provide different types of distribution options in their plan document. Options include hardship withdrawals and distributions after meeting a certain age or service requirement (as applicable).

Differences in plan design types: SIMPLE IRA, SEP, 401(k) plans

Now that you know the components under each retirement plan design, you’ll be able to understand the differences between each retirement plan better. A few common small business plans include SIMPLE IRA plans, SEP IRA plans, and 401(k) plans. 

• SIMPLE IRA plan: SIMPLE IRA plans are only available to businesses with less than 100 employees. They generally have lower overhead costs than other types of 401(k) plans. Each year, employers offering a SIMPLE IRA plan must make a matching contribution of up to three percent of compensation or a two percent nonelective contribution per employee. 

• SEP IRA plan: Businesses of any size can choose to set up a SEP plan, including self-employed individuals, which essentially allows employers to contribute to their employees' traditional IRAs. An IRA allows employees to save for retirement on a tax-deferred basis. 

• 401(k) plan: The traditional 401(k) plan can be offered by businesses of any size. The 401(k) has higher contribution limits than the SIMPLE IRA and SEP IRA. Additionally, employers are not required to contribute to their employee’s 401(k) accounts (although many employers do). 

Learn more about the differences between 401(k), SIMPLE IRA, and SEP IRA plans.

How the SECURE Act may impact your clients

Passed in late 2019, the SECURE Act was partly designed to encourage more Americans to contribute to a retirement plan. One of the ways this was accomplished was to make it easier for small businesses to provide retirement plans, primarily through tax credits, and by expanding retirement coverage to employees who were previously ineligible to participate in a plan (i.e. part-time workers). 

For example, small businesses with less than 100 employees can earn tax credits of up to $5,000 to cover plan start-up costs each year for three years (a total of $15,000 in tax credits). Additionally, small businesses can earn credits for implementing automatic enrollment provisions in their 401(k) plan.

State mandates

As more states pass legislation requiring private sector businesses to provide retirement savings options for their employees, business owners must adopt a retirement plan option to avoid incurring hefty penalties. 46 states have either implemented a state-based retirement savings program, studied program options, or considered legislation to encourage more private-sector employers to provide retirement plans to their employees. 

As of 2022, the following states have active retirement laws that require employers to offer their employees retirement savings opportunities: 

• California

• Connecticut

• Illinois 

• Massachusetts

• Maryland

• Oregon

• Washington

The majority of state-sponsored retirement plans are Roth IRAs. While Roth IRAs have their advantages, they may not always be the best retirement plan for small businesses that are looking to get tax deductions on contributions or make matching contributions to their employees’ retirement accounts. In comparison to 401(k)s, Roth IRAs have lower contribution limits, participation is subject to income limitations and employee contributions must be made post-tax. 

How to bring up a 401(k) with your clients

Talking to your clients about retirement planning may be daunting, but it is an important conversation. You may want to emphasize that planning ahead can help your small business clients reach their retirement goals faster because the earlier one starts, the more likely they’ll have enough money for the future due to the potential effects of compound interest, as illustrated in this example graphic below.¹

Some other talking points that you can broach with your small business clients is that offering a 401(k) can help to retain and attract employees. 

It might also be helpful to clarify that 401(k)s are not exclusively for larger businesses. Whether a business is a sole proprietorship or an LLC, there are retirement plans that are meant to be more cost-effective and flexible for businesses with less than 100 employees. 

And FYI—some 401(k) providers offer technology such as payroll integration and reporting capabilities to make it easier to track, administer, and manage 401(k) benefits. 

Human Interest can act as 3(16), 3(21), 3(38) fiduciary

Businesses that offer retirement plans are required to meet fiduciary responsibilities under ERISA. The primary ERISA fiduciary duty is to run the plan solely in the interest of participants and beneficiaries for the exclusive purpose of providing benefits and paying plan expenses. Human Interest can take on certain fiduciary responsibilities for 401(k) plan sponsors, which include 3(16), 3(21), and 3(38) duties: 

• 3(16): The 3(16) fiduciary is responsible for day-to-day administration decisions for a plan. Those duties typically involve performing non-discrimination testing, processing employee deferral elections, and signing and filing Form 5500. 

• 3(21): A 3(21) co-fiduciary can make recommendations on plan investment opinions or provide advice on other plan-related matters. However, they cannot make investment decisions without approval from the client. 

• 3(38): A 3(38) fiduciary has the power to select, monitor, and replace investments for a retirement plan on behalf of a client. They do not need approval from the client to make decisions on the plan’s assets. 

Choosing a 401(k) fiduciary can benefit small business owners. It can be a hassle to meet compliance requirements set by the Department of Labor, and outsourcing some of the fiduciary responsibility can help alleviate much of the burden. 

Learn more about Human Interest

If your small business client is interested in choosing a fiduciary to help manage their 401(k) plan, you may want to consider Human Interest. At Human Interest, we can provide investment services as either your 3(38) fiduciary or 3(21) co-fiduciary. We also offer 3(16) fiduciary services where we review and approve distribution requests, file and sign your Form 5500, and more. In addition, all levels of administration offer full 401(k) plan compliance with testing, IRS Form 5500 preparation, preparation of IRS pre-approved plan documents, audit packages, preparation of participant disclosures, and in-house recordkeeping services.