401(k) employer benefits: Advantages of offering a 401(k)

401(k) retirement plans offer significant benefits to employers, ranging from tax advantages to enhanced company reputation. A strong retirement plan can play a role in attracting and retaining top talent. This article will delve into the specifics of a 401(k) retirement plan for a business, examine the benefits and limitations, and discuss the different options available for organizations.

What is a 401(k) plan?

A 401(k) plan, named after section 401(k) of the IRS code, is an employer-sponsored retirement savings plan. The plan allows eligible employees to make elective deferrals from their salary, either on a pre-tax or Roth basis. Employers may also make contributions to the plan, enhancing retirement savings for their employees. One of the objectives of a 401(k) plan is to help eligible employees save more for retirement over time.

Benefits of offering a 401(k) plan for small and medium Businesses

1. Attracting and retaining top talent

In today's competitive job market, a standout benefits package is not just a perk—it may be considered a necessity for attracting and retaining the best professionals. At the heart of such a package is often a robust retirement savings plan.

A study by Human Interest from 2022 highlights the value employees place on retirement benefits, showing that 401(k) was listed as the second most wanted benefit, right after health insurance, across 2,000 Americans. This preference underscores the critical role that a 401(k) plan can play in making your business more appealing to potential hires.

But the benefits of offering a 401(k) extend beyond just drawing in talent. It's about keeping them too. A Gusto study found that “workers are on average 40% less likely to leave in the first year when they are offered retirement benefits”. They noted this effect is highest for firms in the Retail and Food & Beverage sectors which are the least likely to offer a retirement plan. A 401(k) plan is more than a financial tool for employees; it's a signal that you're invested in their long-term well-being and success. 

2. Tax advantages 

One of the most compelling reasons for small and medium-sized businesses to offer a 401(k) plan lies in the substantial tax advantages provided by legislation, particularly under the SECURE Act and its expansion, SECURE Act 2.0. These tax incentives not only make it more affordable for businesses to start and maintain retirement plans but also reward them for contributing to their employees' retirement savings.

Doubling of tax credits for new plans

Small businesses with up to 50 employees can now enjoy an increased tax credit for plan start-up costs. Under SECURE Act 2.0, the tax credit has been elevated to 100% of these costs, up from the previous 50%, capped annually at $5,000 per employer for each of the first three years. This adjustment means a potential total tax credit of up to $15,000, significantly offsetting the initial financial barrier to setting up a 401(k) plan. Businesses with 51 to 100 employees continue to benefit from the original tax credits, covering 50% of administrative costs up to $5,000 annually for three years.

Expansion of eligibility for start-up tax credit

The legislation broadens the eligibility for the start-up tax credit, extending it to employers who join existing multiple employer plans (MEPs) in addition to those establishing new plans. This change encourages more businesses to participate in retirement savings programs by making it financially advantageous to do so.

New credits for employer contributions

An innovative aspect of SECURE Act 2.0 is the introduction of a new tax credit for small businesses (with up to 50 employees) based on employer contributions. This credit can amount to up to $1,000 per employee, for those earning less than $100,000 annually, and is designed to incentivize businesses to contribute more towards their employees' retirement savings.

For businesses with 51 to 100 employees, the credit phases in, providing a scaled benefit designed to support growing businesses as they enhance their retirement offerings.

Tax credit for auto-enrollment 

In addition to these new incentives, the tax credit for adopting auto-enrollment remains in place, offering $500 per year for the first three years. This credit supports businesses in increasing plan participation rates, further bolstering employees' retirement savings.

3. Tax-deductible matching contributions

One of the most strategic ways for employers to encourage retirement savings among their workforce is through matching contributions. This approach involves the employer committing to contribute a certain amount to an employee's 401(k) plan, matching the employee's own contributions up to a specified percentage of their salary. 

This not only motivates employees to participate in the plan but can also help drive higher contributions to their retirement plan, knowing that their efforts can be compounded. 

The benefits of offering a matching contribution extend well beyond just the immediate value it provides to employees. For employers, these contributions are tax-deductible, allowing businesses to reduce their taxable income while investing in their employees' futures. 

Essentially, any amount a business contributes to its employees' 401(k) plans can be deducted from the company's taxable income, thereby lowering the overall tax liability for the business. 

This deduction applies to all types of employer contributions, whether they are matching a portion of employee contributions or providing non-elective contributions that do not require employee participation to receive.

4. Helps you save for your own retirement 

401(k) plans offer significant advantages not just for employees but for the business owners who employ them as well. As a small or medium-sized business owner, contributing to your company's 401(k) plan is a strategic move for your financial future, allowing you to enjoy the same tax-deferred growth on your investments as your employees. If you make pre-tax deferrals, this means the money you invest grows without being taxed on its gains until you're ready to withdraw, potentially saving you a substantial amount over the years.

Employer Considerations for a 401(k) Plan

Implementing a 401(k) plan comes with numerous benefits for both employees and employers, but it also requires thoughtful consideration of several key aspects to ensure its success and alignment with your business goals. Here's a closer look at these considerations:

Plan administration

Navigating the administration of a 401(k) plan is a critical aspect for employers. It encompasses a range of tasks from the setup phase to ongoing management, all while complying with the Employee Retirement Income Security Act (ERISA). 

ERISA mandates standards for investment advice, fiduciary responsibilities, and information disclosure, necessitating vigilant oversight. For small and medium-sized businesses, understanding these regulations is essential, albeit potentially challenging without a specialized HR or benefits team. 

The administrative effort and the need for external advisors or administrators should be considered as part of your planning process to ensure effective compliance and management of the plan.

Cost

The financial investment in offering a 401(k) plan varies based on the design of the plan and the chosen provider. Initial startup costs and ongoing expenses such as administration fees, investment management, and record-keeping are important factors to consider. These expenses are influenced by participant numbers, plan customization, and investment options. 

While these costs represent a financial commitment, they can be viewed as an investment in employee satisfaction and retention, with potential tax advantages offering some offset. Evaluating different providers and plan options carefully will help you identify a cost-effective approach that suits your business's financial capacity and objectives.

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Vesting schedule

The vesting schedule is an important feature of a 401(k) plan, outlining the timeframe employees must work before gaining full ownership of employer contributions. Implementing a vesting schedule can serve as an incentive for employee retention, although it might initially appear as a drawback to newer employees due to delayed benefits. 

The challenge lies in striking a balance between incentivizing long-term employment and maintaining an attractive benefits package for all employees. Careful consideration of how the vesting schedule aligns with your company's retention strategies and overall benefits offering is crucial.

Automatic enrollment

Incorporating automatic enrollment into your 401(k) plan is another strategic consideration that can significantly impact participation rates. This feature automatically enrolls employees in the 401(k) plan upon eligibility, though they can choose to opt-out.

Automatic enrollment can simplify the participation process, leading to higher enrollment rates and potentially more savings for employees over time. Additionally, businesses may qualify for a tax credit of up to $500 per year for the first three years after adding this feature to a new or existing plan. When considering automatic enrollment, evaluate how it fits with your company's culture and benefits strategy, as well as its potential to boost savings and engagement in the plan.

Note: For plans launched on 12/29/22 or later, automatic enrollment will be required starting in 2025. 

Safe harbor plans as a strategic option

For employers considering a 401(k) plan, a safe harbor provision offers a streamlined way to satisfy IRS non-discrimination requirements, bypassing certain annual IRS tests by making mandatory contributions to employees. This approach not only simplifies plan compliance but also enhances plan attractiveness by ensuring employer contributions are accessible to all employees.

These mandatory contributions are typically "fully vested", meaning they are immediately owned by the employee. However, it is important to note that under a Qualified Automatic Contribution Arrangement (QACA), a type of safe harbor plan, the "fully vested" status may not apply until after two years of service, introducing a "2-year cliff" where employees must wait two years to gain full ownership of these contributions.

Given these variations, especially for businesses with fluctuating revenues, balancing compliance ease and employee benefits against the company’s budgetary constraints requires careful consideration.

The benefits of a Human Interest 401(k)

Understanding the challenges small and medium-sized businesses face, Human Interest has designed its 401(k) plans to be both accessible and beneficial. Key features include streamlined plan administration, easy integration with existing payroll systems, and educational resources to empower employees in their retirement planning. By reducing the complexity and burden of plan management, Human Interest enables employers to focus on what they do best—growing their business and supporting their workforce.

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