401(k) rules for employers: The basics and benefits


By The Human Interest Team

Key Takeaways

  • 401(k) plans are a good way to save money for the future—and for both employers and employees to save on taxes.

  • From establishing vesting schedules to satisfying IRS requirements, there are steps businesses must take to set up a plan.

  • Learn how to find a 401(k) plan that fits your organization’s needs regarding size, administration, and ease-of-use.

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've been around for 40 years.

At Human Interest, we offer 401(k) plans for small businesses and startups. 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 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 401(k)s 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 2020 and 2022 (there was no increase in contribution limit for 2021), individuals may contribute up to $20,500 to a 401(k). However, if they’re at least 50 years old, that limit is raised to $27,000. The IRS can establish new 401(k) and IRA contribution limits every year. The key thing to note here: employer contributions are not considered against this annual cap.

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:

  • Saving money for retirement

  • Tax savings due to contributing pre-tax dollars (read more about 401(k) match contribution tax deductions)

  • Tax-free growth throughout the investment’s life

  • Access to multiple investment options

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401(k)s are in reach for small businesses.

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

The IRS has requires that a 401(k) plan satisfy a whole host of criteria, including:

  • Contribution limits: The IRS determines annual contribution limits for 401(k) plans. There are two limits: one for employee contributions, and the other for overall contributions (including the total of all employee and employer contributions). Employees who are age 50 and older by the end of the year may also make additional “catch-up” contributions up to an amount determined by the IRS.

  • Distribution rules: The money inside a 401(k) plan grows tax-deferred, but withdrawals must meet specific conditions, such as the employee’s retirement, death, disability, or separation from employment. Additionally, if an employee reaches the age of 59 1/2, or experiences a hardship, as defined and permitted by the plan, they may also withdraw funds.

  • Limits for high-income earners: As determined by the IRS, employees whose annual income or percentage ownership in the company meets a specific threshold may only contribute a portion of their earnings. The IRS performs non-discrimination testing (NDT) on 401(k) plans to ensure that these highly compensated employees are not contributing disproportionately more than other employees at the company.

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:

  • Find a 401(k) plan that fits your organization’s needs regarding size, administration, and ease-of-use

  • Make sure your 401(k) administrator is a fiduciary

  • Draft a written plan that identifies what your 401(k) will offer (e.g., employer match)

  • Provide eligible employees with information about the plan

  • Monitor results and (if applicable) measure the administrator’s effectiveness

  • Follow all 401(k) reporting requirements

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

  • I am the owner or benefits administrator of a startup or small business.

  • I am dreading the impending paperwork and setup/maintenance time of a 401(k).

  • I am not interested in becoming a compliance expert and learning all about the IRS’s annual 401(k) nondiscrimination testing.

  • I want a 401(k) that will integrate directly with my payroll provider and automatically deduct and monitor contributions.

  • I want the best possible investment choices and low fees for my employees.

  • I want to pay an affordable administration fee. Read our guide about the cost of 401(k) plans for employers.

  • I want to outsource the monthly/bimonthly/yearly administration and maintenance of our 401(k).

  • I want to work with a top 401(k) provider that does not receive any kickbacks from funds and has no financial motivation to provide misleading information (best 401(k) plans).

  • I want to increase my 401(k) participation rates.

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.

The Human Interest Team

Article By

The Human Interest Team

We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment advising, and integration with leading payroll providers.

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