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  • Small Business Overview

Small-business 401(k)

Fidelity's 401(k) plans for small businesses through Fidelity Workplace Services can help you offer competitive benefits to your employees. Offering a retirement plan is a smart way to help level the professional playing field between your small business and larger companies.

A good retirement plan can help you:

  • Attract talented people in today's challenging job market.
  • Retain valuable employees who want retirement options in their benefits package.
  • Enjoy tax advantages that may be available to you as an employer offering the plan.

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We offer a variety of tax-advantaged small-business plans for self-employed professionals, entrepreneurs, and business owners and their employees.

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An Individual 401(k) maximizes retirement savings if you're self-employed or a business owner with no employees other than a spouse. We also offer an Individual Roth 401(k) option.

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A SIMPLE IRA (Savings Incentive Match Plan for Employees) is a great starter plan that encourages employees to contribute.

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Selecting Vanguard for your retirement plan means you can expect high-quality, low-cost funds; investment flexibility; and exceptional service—all from a partner trusted by businesses like yours to align with our clients' interests.

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All retirement plans offer tax-deferred growth on earnings. As an employer, you also benefit from tax-deductible employer contributions.

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In addition to your plan contributions, the compounding of interest, dividends, and capital gains allows your account to generate earnings on top of earnings.

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Offering a retirement plan to your employees can keep you competitive in the job marketplace and help your business flourish.

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A Small Business Owner’s Guide to Setting Up Retirement Plans for Employees

Jayme Richards - Guest Contributor profile picture

Jayme Richards - Guest Contributor

Learn how to retain employees with the right small-business retirement savings plan..

The COVID-19 pandemic has disrupted the financial plans of millions of people.

According to a 2020-21 survey by Age Wave and Edward Jones , one in three Americans are planning to postpone their retirement plans due to the pandemic, while 14 million have stopped monthly contributions to their retirement accounts altogether (as of March 2021). A whopping 70% say the pandemic has prompted them to prioritize long-term financial planning.

However, the Bureau of Labor Statistics reports that only 67% of private industry workers had access to employer-provided retirement plans in 2020. That means over 33% of workers don’t have employer support when it comes to retirement savings.

As a small business owner, you can do your part by establishing a retirement savings program to ensure your employees have financial security amid difficult times. In this article, we explain some popular retirement plans for small businesses as well as define the steps to set up a retirement package for your employees.

Retirement plan options for your small business

Here are some small business retirement plan options you can consider:

1. 401(k) plan

In a 401(k) plan, you as the employer place a percentage of a consenting employee’s paycheck into an investment account, where the retirement funds grow tax-free. Employees can choose how much they want to contribute and which funds they want to invest in. However, they are limited to the selection of investment tools your chosen plan provides.

401(k)s are particularly attractive for employees because they come with company-sponsored contributions. For example, if an employee contributes $1,000 to their account, you can contribute 50% of the amount (i.e., $500), adding to their investment. If these contributions seem costly to you, note that they can be deducted from your company’s federal income tax.

There are two common types of 401(k) plans: traditional 401(k)s and Roth 401(k)s. Per Marcus’ guide to 401(k) plans , the main difference between the two plans is when tax benefits come into effect.

A traditional 401(k) lets employees deduct contributions from their taxable income; their earnings are taxed once they withdraw their retirement funds. A Roth 401(k) plan, on the other hand, takes contributions from employees’ post-tax income only. Since employees have already paid their dues, their capital gains aren’t taxed once withdrawn.

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Things to know about traditional 401(k) plans ( Source )

Marcus also notes that many 401(k)s come with a vesting schedule. For instance, some 401(k) plans may not allow employees to take employer contributions if they leave the company before an agreed-upon date. Such plans incentivize employees for their company loyalty, potentially reducing your small business’s turnover rate.

2. SIMPLE IRA

Savings Incentive Match Plans for Employees, or SIMPLE IRAs, were designed to simplify retirement savings plans for small businesses. SIMPLE IRAs have lower account management fees than 401(k) and IRA plans and also have fewer restrictions.

Overview of SIMPLE IRAs ( Source )

The IRS notes that SIMPLE IRAs are available only to companies with 100 or fewer employees , so they’re perfect for small businesses.

In a SIMPLE IRA, you roll a fraction of each employee’s salary into their designated investment accounts. You’re also required to make contributions of up to 3% of your employee’s salary. Plus, you have the option to contribute even if your employees choose not to, and your contribution is tax-deductible—a win-win situation.

3. Payroll deduction IRA

If you can’t afford contributions to a 401(k) plan, you can set up a payroll deduction IRA. Similar to a 401(k), a payroll deduction IRA lets you take an employee-elected percentage off their monthly paycheck, which you then roll into a tax-advantaged investment account. Your employees can choose which assets they want to invest in. Unlike 401(k)s, in IRAs, employees aren’t limited to the assets chosen by your company’s provider.

Since employers make no contributions, establishing a payroll deduction IRA won’t get you any tax deductions. Your employees, however, can enjoy pre- and post-tax advantages. If they opt for a traditional IRA, their contribution can be deducted from their payable taxes, but their capital gains will be taxable. And if they opt for a Roth IRA, their contributions can only come from post-tax income, which makes capital gains tax-free.

Calculating employee benefits costs for your small business

To summarize, 401(k) plans and SIMPLE IRAs might be more expensive should you opt to match employee contributions, but these expenses can be deducted from your company’s taxable income. SIMPLE IRAs also come with lower provider costs. On the other hand, payroll deduction IRAs don’t require employer contributions but also offer no tax benefits.

As a small business owner, you should realize that attractive retirement packages help attract as well as retain top talent. This is particularly true for employer matching, which incentivizes employees to perform well and contribute to your company’s bottom line.

For starters, evaluate your company’s current financial situation to determine which plan you can afford. If retirement programs aren’t the only employee benefit you plan to offer, use our Employee Benefits Cost Calculator to get an estimate of your overall costs. Remember, no matter which retirement plan you choose, you’ll still be legally required to match Social Security and Medicare contributions from your employees’ paychecks.

3 steps to set up a retirement package

Follow these three steps to set up an employee retirement plan for your small business:

1. Look for a plan provider

To set up a 401(k) or IRA plan, you first need to find a plan provider—preferably one that specializes in employee retirement plans for small businesses. Financial institutions such as banks and brokerages offer these services. Most providers charge a fee for helping manage your employees’ assets, so it's best to look for providers with low service fees.

2. Make it official

Make things official by creating a written document that outlines the benefits, rights, and features your plan provides. If you choose to establish a 401(k) plan, you’re legally required to place the assets included in each employee’s plan under designated trust accounts. This helps ensure any deposits are only used by the participant and beneficiary of each trust account—meaning you and your employees. Thereafter, establish an organized recordkeeping system to track all the assets involved.

3. Share the details with your employees

Finally, share the plan details with all employees. Make sure they’re aware of all provider costs, such as annual and transfer fees. Should they decide to enroll in the plan, allow them to select the percentage of their paycheck they intend to contribute.

Exception for SIMPLE IRAs: The setup process is easier for SIMPLE IRAs. All you need to do is fill out either Form 5304-SIMPLE or Form 5305-SIMPLE. Fill out Form 5304 if you want to give your employees the freedom to choose which financial institution will host their IRA. On the other hand, if you want all employees to partner with a single company-selected provider so it’s easier to track investments, fill out FORM 5305 instead.

Retain talent and enjoy tax benefits with retirement planning plans

Every employee deserves a peaceful retirement. When you create retirement programs that incentivize saving for the future, you prove to your workers that they’re valuable to your company. Your employees are happier, which helps reduce your business’s turnover rate and makes you competitive in the job market. Not just that, you also benefit from making tax-deductible employer contributions.

Are you interested in becoming a guest writer for Capterra? Reach out to [email protected] for details.

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About the author.

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Jayme Richards is a financial analyst turned small business owner. After three years in the corporate setting, Richards sought greener pastures and went into business for herself. She is now in the process of launching her online store, hoping to ride the eCommerce wave.

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What Is a Solo 401(k)?

How the solo 401(k) works.

  • Who Is Eligible?

How to Set Up a Solo 401(k) Plan

  • Eligibility Requirements
  • Contribution Limits

Other 401(k) Plans

Contributions example, other benefits of a solo 401(k), the bottom line.

  • Retirement Planning

A 401(k) Plan for the Small Business Owner

The solo 401(k) plan is worth a look

setting up a retirement plan for your business

Roger Wohlner is an experienced financial writer, ghostwriter, and advisor with 20 years of experience in the industry.

setting up a retirement plan for your business

The 401(k) plan has gained popularity among small business owners ever since 2001 when some changes to federal tax law made it a better and more flexible choice for their needs compared with some other retirement savings options. These 401(k) plans are known as solo 401(k) or self-employed 401(k) plans.

Key Takeaways

  • A solo 401(k) plan—also called a self-employed 401(k)—is for businesses whose only eligible participants in the plan are its owners (and spouses).
  • These plans are often less complicated and cost less to set up.
  • If you have non-owner employees, they must not meet the eligibility requirements you select for the plan.
  • There are two components to a solo 401(k) plan: employee elective-deferral contributions and profit-sharing contributions.
  • A solo 401(k)s may also offer loans, doesn’t require nondiscrimination testing, and allows for the deduction of plan contributions of up to 25% of eligible compensation.

Solo 401(k)s are a retirement savings option for small businesses whose only eligible participants in the plan are the business owners (and their spouses if they are also employed by the business). It can be a smart way for someone who is a sole proprietor or an independent contractor to set aside a decent-sized nest egg for retirement.

Not content with the federal acronym, various financial institutions have their own names for the solo 401(k) plan. The independent 401(k) is one of the most generic. Other examples include:

  • The Individual(k)
  • Solo 401(k) or Solo-k
  • One-Participant k
  • Self-Employed 401(k)

If you are not sure which name your financial service provider uses, ask about the 401(k) plan for small business owners. The IRS provides a handy primer on such plans.

Who Is Eligible for Solo 401(k) Plans?

A common misconception about the solo 401(k) is that it can be used only by sole proprietors. In fact, the solo 401(k) plan may be used by any small businesses, including corporations, limited liability companies (LLCs), and partnerships. The only limitation is that the only eligible plan participants are the business owners and their spouses, provided they are employed by the business.

A person who works for one company (in which they have no ownership) and participates in its 401(k) can also establish a solo 401(k) for a small business they run on the side, funding it with earnings from that venture. However, the aggregate annual contributions to both plans cannot collectively exceed the Internal Revenue Service (IRS)-established maximums.

For small business owners who meet certain requirements, most financial institutions that offer retirement plan products have developed truncated versions of the regular 401(k) plan for use by business owners who want to adopt the solo 401(k).

As a result, less complex documentation is needed to establish the plan. Fees may also be relatively low. Make sure to receive the proper documentation from your financial services provider.

As noted above, the solo 401(k) plan may be adopted only by businesses in which the only employees eligible to participate in the plan are the business owners and eligible spouses. For eligibility purposes, a spouse is considered an owner of the business, so if a spouse is employed by the business, you are still eligible to adopt the solo 401(k).

If your business has non-owner employees who are eligible to participate in the plan, your business may not adopt the solo 401(k) plan. Therefore, if you have non-owner employees, they must not meet the eligibility requirements you select for the plan, which must remain within the following limitations.

You may exclude nonresident aliens from a solo 401(k) who receive no U.S. income and those who receive benefits under a collective-bargaining agreement.

Solo 401(k) Eligibility Requirements

Setting the wrong eligibility requirements could result in you being excluded from the plan or non-owner employees being eligible to participate in the plan.

For example, say you elect zero years of service as a requirement to participate, but you have five seasonal employees who work fewer than 1,000 hours each year. These employees would be eligible to participate in the plan because they meet the age and service requirements. Consequently, their eligibility would disqualify your business from being suitable to adopt the solo 401(k) plan. Instead, you could adopt a regular 401(k) plan.

Some solo 401(k) products, by definition, require further exclusions. Before you decide to establish a solo 401(k) plan, be sure to check with your financial services provider regarding its provisions.

Contribution Requirements

For 401(k) employee elective-deferral contributions you may require an employee to perform one year of service before becoming eligible to make elective-deferral contributions .

For profit-sharing contributions, you may require an employee to perform up to two years of service in order to be eligible to receive  profit-sharing contributions. However, most solo 401(k) plans will limit this requirement to one year.

For plan purposes, an employee is considered to have performed one year of service if they work at least 1,000 hours during the year. While you may generally choose to require fewer than 1,000 hours under a regular qualified plan, most solo 401(k) plans include a hard-coded limit of 1,000 hours.

Solo 401(k) Contribution Limits

There are two components to the solo 401(k) plan: employee elective-deferral contributions and profit-sharing contributions.

Employee Contribution Limits

You may make a salary-deferral contribution of up to 100% of your compensation but no more than the annual limit for the year. For 2023, the limit is $22,500 (increasing to $23,000 for 2024), plus $7,500 for people age 50 or over for both years.

Employer Contribution Limits

The business may contribute up to 25% of your compensation (calculations are required in the case of the self-employed) but no more than $66,000 for 2023 ($69,000 for 2024). An employee aged 50 or above can still contribute an additional $7,500 for 2023 and 2024.

In comparison with other popular retirement plans, the solo 401(k) plan has high contribution limits as outlined above, which is the key component that attracts owners of small businesses. Some other retirement plans also limit the contributions by employers or set lower limits on salary-deferred contributions.

The following is a summary of contribution comparisons for the employer plans generally used by small businesses.

As mentioned earlier, you may make employee elective-deferral contributions of up to 100% of your compensation but no more than the elective-deferral limit for the year. Profit-sharing contributions are limited to 25% of your compensation (or 20% of your modified net profit if your business is a sole proprietorship or partnership).

The total solo 401(k) contribution is the employee elective-deferral contribution plus the profit-sharing contribution—up to $66,000 for 2023 and 69,000 for 2024.

If your business is a corporation, the profit-sharing contribution is based on the W-2 wages you receive. If you receive $70,000 in W-2 wages, for instance, your profit-sharing contribution could be up to $17,500 ($70,000 x 25%). When added to a salary-deferral contribution of $19,000, the total would be $36,500.

If your business is a sole proprietorship or partnership, the calculation gets a little more involved. In this case, your profit-sharing contribution is based on your modified net profit and is limited to 20%. The IRS provides a step-by-step formula for determining your modified net profit in IRS Publication 560.

There are a number of other benefits that come with the Solo 401(k).

As with other qualified plans, you may be able to borrow from the solo 401(k) up to (1) the greater of $10,000 or 50% of the balance or (2) $50,000, whichever is less. Check the plan document to determine if any other limitations apply.  

5500 Filing May Not Be Required

Because the plan covers only the business owner, you may not be required to file Form 5500 series return unless your balance exceeds $250,000.

No Nondiscrimination Testing

Generally, certain nondiscrimination testing must be performed for 401(k) plans. These tests ensure that the business owners and higher-paid employees do not receive an inequitably high amount of contribution when compared with lower-paid employees.

Such tests can be very complex and may require the services of an experienced plan administrator , which can be costly. Because the solo 401(k) plan covers only the business owner, there is no one against whom you can discriminate, so these tests are not required.

Deducting Contributions

Similar to other employer plans, the solo 401(k) allows you to deduct plan contributions of up to 25% of eligible compensation. For plan purposes, compensation is limited to $330,000 in 2023 and $345,000 in 2024. Earnings over that amount are disregarded for plan purposes.

Can I Have a 401(k) for My LLC?

Yes, any business is able to set up a 401(k). If you are self-employed, you can create a solo 401(k) as a limited liability company (LLC)—assuming you meet all the other eligibility requirements.

What Is the Minimum Number of Employees Needed for a 401(k)?

A business of any size can offer a 401(k) plan. A solo 401(k) is for business owners with no employees.

How Much Can a Small Business Owner Contribute to a 401(k)?

The maximum contribution for a small business owner to a 401(k) for 2023 is $66,000 ($73,500 if you’re 50 or older)—which includes contributions as the employee and employer. For 2024, the contribution limit is $69,000, and $76,500 if you are 50 or older.

If you own more than one business, you must check with your tax professional to determine whether you are eligible to adopt the solo 401(k) . Ownership in another business that covers employees other than the business owner could result in your being ineligible for this type of plan.

Internal Revenue Service. " One-Participant 401(k) Plans ."

Internal Revenue Service. " Retirement Plans for Self-Employed People ."

Internal Revenue Service. " Tax Guide for Small Business (For Individuals Who Use Schedule C) .” Pages 2-3.

Internal Revenue Service. " Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits ."

Internal Revenue Service. “ Election for Married Couples Unincorporated Businesses .”

Internal Revenue Service. “ 401(k) Plan Fix-It Guide - Eligible Employees Weren't Given the Opportunity to Make an Elective Deferral Election (Excluding Eligible Employees) .”

Internal Revenue Service. “ A Guide to Common Qualified Plan Requirements .”

Internal Revenue Service. “ 401(k) Plan Qualification Requirements .”

Internal Revenue Service. " 401(k) Limit Increases to $23,000 for 2024, IRA Limit Rises to $7,000 ."

Internal Revenue Service. " 2024 Limitations Adjusted as Provided in Section 415(d), etc ." Page 1.

Internal Revenue Service. " 2024 Limitations Adjusted as Provided in Section 415(d), etc ." Page 2.

Internal Revenue Service. “ Retirement Topics - SIMPLE IRA Contribution Limits .”

Internal Revenue Service. " Publication 560: Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans) .” Page 6.

Internal Revenue Service. " Publication 560: Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans) .” Page 12.

Internal Revenue Service. " Publication 560: Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans) .” Page 23.

Internal Revenue Service. " Retirement Plans FAQs Regarding Loans ." Select "4. Under What Circumstances Can a Loan Be Taken From a Qualified Plan?"

Internal Revenue Service. " 401(k) Plan Fix-It Guide - The Plan Failed the 401(k) ADP and ACP Nondiscrimination Tests ."

Internal Revenue Service. " 401(k) Plan Overview ."

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  • Simplified Employee Pension (SEP) IRA: What It Is, How It Works 16 of 18
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setting up a retirement plan for your business

Setting up a 401k

The decision to set up a 401k is a worthy one for many businesses. It can help employers attract and retain talent, improve employee financial wellness, and save for their own retirement. When done correctly, setting up a 401k may also be tax advantageous.

Table of Contents

What is a 401k?

How do 401k plans work, what are the benefits of offering a 401k to employees, how to set up a 401k for a business, how much does it cost to set up a 401k for small businesses, maintaining 401k plans for a business.

A 401k  is a retirement savings plan  funded primarily by employees with pretax earned wages. Employers have the option to contribute to their employees’ plans, thereby maximizing the full savings potential.

Employees who are enrolled in a 401k  contribute to their retirement savings plan via pretax payroll deductions . Further functionality largely depends on plan design.

Traditional 401k

Business owners who offer a traditional 401k have the flexibility to contribute the same amount to all participating employees, match individual contribution rates, do both or not contribute at all. These contributions aren’t vested until a certain amount of time has lapsed. Two of the vesting schedules permitted by the Internal Revenue Code (IRC) are:

  • 100% vested after three years of service
  • 20% vested after two years of service, followed by an additional 20% each year until employer contributions are 100% vested in year six

Traditional 401k plans are also subject to annual testing to ensure that they don’t disproportionally favor certain participants over others, i.e., highly-paid executives vs. average employees.

Safe Harbor 401k

Employers can avoid annual nondiscrimination testing by designing their 401k as a Safe Harbor plan. The trade-off is that they’re required to contribute to their employees’ plans, either via matching or non-elective contributions. Contributions are also fully vested at the time they are made.

Automatic 401k

An automatic 401k is an ideal option for employers who want to increase plan participation. As the name implies, employees are automatically enrolled at a default contribution rate unless they specifically opt out or change the rate.

Helping employees plan for the future is a big responsibility, but it can also be very rewarding. Employers who offer a 401k may be able to:

  • Attract and retain talent In addition to competitive salaries and health benefits, retirement savings plans can be a major influencer with candidates who are weighing different job offers.
  • Improve retirement readiness Employees who are financially prepared for retirement can leave the workforce when the time is right, thereby creating growth opportunities for other employees and new talent.
  • Take advantage of tax savings Businesses that sponsor a 401k are potentially eligible for a $500 tax credit to cover startup administration costs during the first three years of the plan. Additional tax deductions may be available if the employer matches employee contributions.
  • Enhance productivity through financial wellness A retirement savings plan is one of the cornerstones of financial wellness . And when employees feel secure about their future, they tend to be less stressed and more productive at work.

What are the benefits of a 401k compared to other retirement options?

Compared to simplified employee pension individual retirement accounts (SEP IRAs) and savings incentive match plans for employees (SIMPLE IRAs), 401k plans have higher annual contribution limits. Thus, employees may be able to save more money in a shorter amount of time with a 401k, making it ideal for those who are older and short of their savings goals. It also allows employees to borrow money from their retirement savings accounts. SEP IRA and SIMPLE IRA plans do not.

What is a SIMPLE IRA?

A SIMPLE IRA is a retirement savings plan designed for small businesses , particularly those with less than 10 employees. As such, it’s typically low cost and easy to set up and administer. Employees who participate in a SIMPLE IRA can defer a percentage of their salary to their savings account and their employer is required to either match it or make non-elective contributions.

What's the difference between a traditional 401k and a Roth IRA?

The primary difference between a 401k and a Roth IRA is how the savings are taxed. Contributions to a 401k are made before tax deductions, whereas those to a Roth IRA are made after tax deductions. When employees retire, their income from a 401k savings plan is subject to taxes. Qualified withdrawals from a Roth IRA, on the other hand, are tax free.

setting up a retirement plan for your business

The path to a successful retirement savings program starts with plan design. And while it’s true that employers can set up 401ks on their own, it’s generally recommended to seek the help of a professional or a financial institution. They’ll provide expert guidance throughout each of the following steps:

  • Draft a 401k policy document Plan documents typically outline the type of 401k chosen – traditional, Safe Harbor or automatic – and key details, such as employee eligibility, contribution levels, etc. The process by which contributions are deposited into the plan and other essential functions may also need to be documented, per legal requirements.
  • Choose a trust to hold plan assets At least one trustee must be chosen to manage plan contributions, investments and distributions. This decision is especially important because financial integrity, i.e., ensuring that assets are only used for the benefit of plan participants and their beneficiaries, depends upon it.
  • Establish recordkeeping methods A recordkeeping system is necessary to keep track of contributions, investments, earnings and losses, expenses, and distributions. It also comes in handy at year’s end when 401k plan reports have to be filed with government agencies.
  • Provide information to eligible participants Employers who sponsor a 401k are required to provide eligible participants with a summary plan description (SPD), as well as information regarding their rights and plan benefits and features. SPDs are usually written in conjunction with the plan document.

The cost of setting up a 401k generally depends on business size, plan design and the extent to which employers make contributions. Employers must also consider the administrative fees of third-party fiduciaries who help manage the plan’s investments. Applying for certain tax credits, however, can help offset some of these costs.

Most 401k plans are subject to the requirements of the IRC and the Employee Retirement Income Security Act (ERISA), which provide minimum standards that protect individuals in retirement plans. Administering and maintaining plans that comply with these regulations ranges in difficulty from the moderate to the complex.

What is the role of the employer in administering 401k plans?

Under ERISA, plan fiduciaries, including the employer and any third parties who manage the plan and its assets, must act solely in the interest of the plan beneficiaries. Some of their responsibilities include:

  • Managing the plan with the exclusive purpose of providing the plan’s retirement benefits to participants
  • Ensuring that the investment menu offers a broad range of diversified investment alternatives
  • Choosing and monitoring plan investment alternatives prudently
  • Ensuring that the costs of plan administration and investment management are reasonable
  • Filing reports, such as Form 5500 Annual Return/Report, with the federal government

These tasks should be taken seriously since fiduciaries can be held personally liable for plan losses or profits from improper use of plan assets that result from their actions.

How long does it take for a small business to set up a 401k?

A start-up 401k plan for a small business typically takes 30 to 45 days to implement, on average. Converting an existing plan from one financial provider to another may take as long as 60 to 65 days.

Questions to expect from 401k participants

Employees who are eligible for an employer-sponsored 401k inevitably will have questions about the plan. Here are some of the most common:

How much should an employer contribute to a 401k?

With a traditional 401k, employers have the flexibility to alter how much they will contribute to their employees’ retirement savings accounts from year to year. Safe Harbor plans, on the other hand, are a bit more restrictive and require one of the following:

  • Match eligible employee contributions dollar for dollar up to 3% of compensation and 50 cents on the dollar for contributions that exceed 3%, but not 5% of compensation.
  • Make non-elective contributions equal to 3% of compensation for all eligible employees.

In total, employer contributions to any type of 401k, combined with employee salary deferrals, cannot exceed the lesser of 100% of employee compensation or the IRS limit for that year.

How much should an employee contribute to a 401k?

How much an employee should invest in a 401k is a personal choice that may depend upon the individual’s age, income and retirement savings goals. Yet, there is one caveat – the IRS imposes an annual maximum on elective deferrals.

How do employers choose the best mutual funds to offer employees?

Managing investments is sometimes beyond the expertise of employers. That’s why many of them outsource the process of selecting, diversifying and monitoring plan investments to an investment advisor. Professional assistance helps ensure that the investment options are in the best interest of the plan and its participants.

This article is intended to be used as a starting point in analyzing 401k and is not a comprehensive resource of requirements. It offers practical information concerning the subject matter and is provided with the understanding that ADP is not rendering legal or tax advice or other professional services. ADP, Inc. and its affiliates do not offer investment, tax or legal advice to individuals. Nothing contained in this communication is intended to be, nor should be construed as, particularized advice or a recommendation or suggestion that you take or not take a particular action.

Unless otherwise agreed in writing with a client, ADP, Inc. and its affiliates (ADP) do not endorse or recommend specific investment companies or products, financial advisors or service providers; engage or compensate any financial advisor or firm for the provision of advice; offer financial, investment, tax or legal advice or management services; or serve in a fiduciary capacity with respect to retirement plans. All ADP companies identified are affiliated companies.

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5 Self-Employed Retirement Plans to Consider

Elizabeth Ayoola

Many or all of the products featured here are from our partners who compensate us. This influences which products we write about and where and how the product appears on a page. However, this does not influence our evaluations. Our opinions are our own. Here is a list of our partners and here's how we make money .

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Being self-employed gives you a certain measure of freedom, but it doesn’t give you an excuse to skip out on saving for retirement.

In fact, it makes putting money away that much more crucial: Unlike an employee who might have access to a 401(k), you’re on your own.

And you might think you'll eventually sell the business and use that money to fund retirement, but what if you don't? Consider a retirement account not only a cushion, but also a tax-advantaged way to reduce income in your high-earning years.

First, you'll want to figure out how much you need to save for retirement with NerdWallet’s retirement calculator . The amount you plan to save each year will help determine the best account for you.

Then decide where to put that money. The good news is that flying solo gives you a lot of options. Here are five self-employed retirement plans that may work for you:

Traditional or Roth IRA

Solo 401(k)

Defined benefit plan

Capitalize

on Capitalize's website

1. Traditional or Roth IRA

Best for: Those just starting out. If you’re leaving a job to start a business, you can also roll your old 401(k) into an IRA .

IRA contribution limit : $7,000 in 2024 ($8,000 if age 50 or older) .

Tax advantage: Tax deduction on contributions to a traditional IRA; no immediate deduction for Roth IRA, but withdrawals in retirement are tax-free.

Employee element: None. These are individual plans. If you have employees, they can set up and contribute to their own IRAs.

» In just a few minutes, you can open an IRA at an online brokerage. Review NerdWallet's picks for the best IRA providers to get started.

The details

An IRA is probably the easiest way for self-employed people to start saving for retirement. There are no special filing requirements, and you can use it whether or not you have employees.

The toughest part might be deciding which type of IRA to open: We’ve given in-depth coverage to the differences between traditional and Roth IRAs , but the tax treatment of a Roth IRA might be ideal if it’s early days for your business (read: you’re not making much money). In that case, your tax rate is likely to be higher in retirement, when you’ll be able to pull that money out tax free. Roth IRAs also don't have required minimum distributions, and Roth IRAs can be transferred to your heirs , tax-free.

One note: The Roth IRA has income limits for eligibility; those who earn too much can't contribute.

» Learn more about IRAs

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2. Solo 401(k)

Best for: A business owner or self-employed person with no employees (except a spouse, if applicable).

Contribution limit: For 2024, it's $69,000, plus a $7,500 catch-up contribution or 100% of earned income, whichever is less [0] IRS.gov . 2024 Limitations Adjusted as Provided in Section 415(d), etc. . Accessed Mar 16, 2022. View all sources , whichever is less. To help understand the contribution limits here, it helps to pretend you’re two people: An employer (of yourself) and an employee (also of yourself).

In your capacity as the employee, you can contribute as you would to a standard employer-offered 401(k), with salary deferrals in 2024 of up to 100% of your compensation or $23,000, plus that $7,500 catch-up contribution, if eligible, whichever is less.

In your capacity as the employer, you can make an additional contribution of up to 25% of compensation. Employer contributions must be made by the tax filing deadline , or extension date if applicable.

There is a special rule for sole proprietors and single-member LLCs: You can contribute 25% of net self-employment income, which is your net profit less half your self-employment tax and the plan contributions you made for yourself.

The limit on compensation that can be used to factor your contribution is $345,000 in 2024.

Tax advantage: This plan works just like a standard, employer-offered 401(k): You make contributions pretax, and distributions after age 59½ are taxed.

Employee element: You can’t contribute to a solo 401(k) if you have employees. But you can hire your spouse so they can also contribute to the plan. Your spouse can contribute up to the standard employee 401(k) contribution limit , plus you can add in the employer contributions, for up to a total of $69,000 in 2024, plus catch-up contribution, if eligible. This potentially doubles what you can save as a couple.

How to get started: You can open a solo 401(k) at many online brokers. You’ll need to file paperwork with the IRS each year once you have more than $250,000 in your account.

This plan, which the IRS calls a “one-participant 401(k),” is particularly attractive for those who can and want to save a great deal of money for retirement or those who want to save a lot in some years — say, when business is flush — and less in others.

Keep in mind that the contribution limits apply per person, not per plan — so if you also have outside employment that offers a 401(k), or your spouse does, the contribution limits cover both plans.

One other thing to know: You can also choose a solo Roth 401(k) , which mimics the tax treatment of a Roth IRA. Again, you might go with this option if your income and tax rate are lower now than you expect them to be in retirement.

» Learn more about the solo 401(k)

Best for: Self-employed people or small-business owners with no or few employees.

Contribution limit: The lesser of $66,000 in 2023, $69,000 in 2024, or up to 25% of compensation or net self-employment earnings, with a $330,000 limit on compensation ($345,000 in 2024) that can be used to factor the contribution. Again, net self-employment income is net profit less half of your self-employment taxes paid and your SEP contribution. No catch-up contribution. Be sure to make your contributions by the federal income tax filing deadline, usually mid-April, or the extension deadline if filing for extension.

Tax advantage: You can deduct the lesser of your contributions or 25% of net self-employment earnings or compensation — limited to that $330,000 cap per employee in 2023 ($345,000 in 2024) — on your tax return. Distributions in retirement are taxed as income. Previously, there was no Roth version of a SEP IRA. Under legislation signed by President Biden in December 2022, Roth contributions are now allowed [0] Senate.gov . SECURE 2.0 Act of 2022 . View all sources .

Employee element: Employers must contribute an equal percentage of salary for each eligible employee, and you are counted as an employee. That means if you contribute 10% of your compensation for yourself, you must contribute 10% of each eligible employee’s compensation.

Get started: You can open a SEP IRA at many online brokers just as you would a traditional or Roth IRA, with a few extra pieces of paperwork.

A SEP IRA is easier than a solo 401(k) to maintain — there’s a low administrative burden with limited paperwork and no annual reporting to the IRS — and has similarly high contribution limits. Like the solo 401(k), SEP IRAs are flexible in that you do not have to contribute every year.

The downside for you, as the business owner, is that you have to make contributions for employees, and they must be equal — not in dollar amount, but as a percentage of pay — to the ones you make for yourself. That can be costly if you have more than a few employees or if you’d like to put away a great deal for your own retirement. You cannot simply use a SEP to save for yourself; if you contribute for the year, you have to make contributions for all eligible employees.

» Learn more about SEP IRAs

setting up a retirement plan for your business

4. SIMPLE IRA

Best for: Larger businesses, with up to 100 employees.

Contribution limit: Up to $15,500 in 2023, plus catch-up contribution of $3,500 in 2023 if you're 50 or older (up to $16,000, plus a catch-up contribution of $3,500 in 2024). If you also contribute to an employer plan, the total of all contributions can’t exceed $22,500 in 2023 or $23,000 in 2024. Contributions must also be made by tax day or the extension deadline if applicable.

Tax advantage: Contributions to a traditional SIMPLE IRA are deductible, but distributions in retirement are taxed. Contributions made to employee accounts are deductible as a business expense. The legislation signed into law in December 2022 allows for Roth contributions, effective in 2023.

Employee element: Unlike the SEP IRA, the contribution burden isn’t solely on you: Employees can contribute through salary deferral. But employers are generally required to make either matching contributions to employee accounts of up to 3% of employee compensation, or fixed contributions of 2% to every eligible employee. Choosing the latter means the employee does not have to contribute to earn your contribution. The compensation limit for factoring contributions is $330,000 in 2023, $345,000 in 2024.

Get started: The process is similar to a SEP IRA — you can open a SIMPLE at an online broker, with a heavier paperwork load than your standard IRA.

If you’re the owner of a midsize company with fewer than 100 employees, the SIMPLE is a fairly good option, as it’s easy to set up and the accounts are owned by the employees.

SIMPLE IRA contribution limits are significantly lower than a SEP IRA or solo 401(k), however, and you may end up having to make mandatory contributions to employee accounts, which can be expensive if you have a large number of employees who participate. Here's more on the SIMPLE IRA vs. a 401(k) .

The traditional SIMPLE IRA is also inflexible, particularly early on: Early withdrawals, before age 59½, are treated the same as early 401(k) or IRA distributions, in that they are taxed as income and subject to 10% penalty. But if you make a withdrawal within the first two years of participation in a SIMPLE IRA, the 10% penalty is increased to 25%. That means you also can’t roll over a SIMPLE to another retirement account within that two-year period. Zing.

One other thing to know: There is a 401(k) version of a SIMPLE, which works in much the same way but allows participants to take loans from their accounts. This version requires more administrative oversight and can be more expensive to set up.

» Learn more about the SIMPLE IRA

5. Defined benefit plan

Best for: A self-employed person with no employees who has a high income and wants to save a lot for retirement on an ongoing basis.

Contribution limit: Calculated based on the benefit you’ll receive at retirement, your age and expected investment returns.

Tax advantage: Contributions are generally tax deductible, and distributions in retirement are taxed as income. An actuary must figure your deduction limit, which adds an administrative layer.

Employee benefit: If you have employees, you generally offer this plan to them and make contributions on their behalf.

Get started: Your options for brokerages are more limited than with the above accounts, but Charles Schwab offers defined benefit plans.

People often lament the decline of pension plans, and this is exactly that: If you’re self-employed, you can set up your own pension — a guaranteed stream of income — in retirement by using a defined benefit plan.

So why wouldn’t everyone do it? They’re expensive, with high setup and annual fees. If you have employees, that fee will likely go up, and you’ll need to contribute on their behalf. They carry a heavy administrative burden each year, and they require a commitment to fund the plan with a certain amount per year. If you need to change that amount, you’ll pay additional fees. To make it worth it, you'd need to continue the plan for at least three years, financial advisors say.

The upsides are that you can stash a lot of cash in these, and you can defer taxes until retirement. If you’re fairly close to retirement, earning a high income that you know you’ll maintain and that allows you to save a significant amount per year — we’re talking $50,000 to $80,000 or more — you might consider using this plan to supercharge your savings efforts.

» Thinking about the future? Learn about succession planning for your business .

Where to open a retirement plan if you’re self-employed

Once you’ve decided to open one of these accounts, you’ll have to decide where to do it.

Most online brokers will allow you to open the four most common account types: IRA, solo 401(k), SEP IRA and SIMPLE IRA. » Ready to get started? Seek our picks for the best IRA providers

Each broker will walk you through the process of opening one of these accounts and explain any paperwork you may need to file with the IRS. But to be on the safe side, you may also want to work with an accountant.

Most financial advisors can also set up retirement plans for you.  

» Want help planning for retirement? Check out our retirement planning guide .

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Learn the basics

Setting up a retirement plan may sound daunting, but it doesn’t have to be.

Business meeting with laptops

Simply Retirement by Principal ® is designed to make it easy to set up a plan yourself, step by step. Once you understand the basics, it’s really just a matter of making choices that fit your situation. Here are a few things to consider as you look at your retirement plan options.

When you’re researching a retirement plan that works for your business, questions may come up. We can help.

Who can offer a retirement plan?

Why offer a retirement plan?

What are some of the potential benefits to your employees?

How much could your employees save for retirement?

What’s involved in managing a 401(k) plan?

How can you protect yourself and limit your liability?

How do automatic enrollment and contributions work?

What are the costs involved in a retirement plan?

Businesses of any size can offer a retirement plan, whether it’s a solo 401(k) for an owner-only operation or a group plan for dozens of employees. No business is too small to qualify. In fact, Simply Retirement by Principal ® is designed for businesses with fewer than 100 employees.

For business owners, potential benefits include:

Recruitment and retention. A retirement plan is a valuable benefit that can help you compete for top talent.

Tax advantages. A new enhancement was made to the tax credits intended to help cover the costs for small employers that choose to offer new defined contribution plans. Small employers with 50 or fewer employees can now count 100% (maximum $5,000 a year) of their qualified plan expenses toward the tax credit calculation, allowing more employers the ability to maximize the tax credit¹. Employers with 51-100 employees can utilize the tax credit under SECURE 2.0 Act of 2019 which is 50% of qualifying start-up costs for new employee retirement plan (maximum $5,000 a year). Small businesses can offset almost all of the plan fees with SECURE 2.0 Act legislation with no more than 50 employees to claim a tax credit of 100% of the qualifying  start-up costs  for a new employee retirement plan for 3 years (maximum $5,000 a year). SECURE Act of 2019 allows a tax credit of 50% of the qualifying start-up costs for a new employee retirement plan for 3 years if the employer has 51-100 employees (maximum $5,000 a year).

There’s also a tax credit for 5 years of up to  $1,000  per employee a year for employer contributions made if employer has no more than 50 employees. Employers with 51-100 employees, the credit is reduced by 2% for each employee in excess of 50. A small employer may also be eligible to claim a $500 tax credit for including an  eligible automatic contribution arrangement with their newplan under SECURE Act of 2019.  Plus, any matching contributions you make to employeeretirement accounts are tax-deductible.

Helping employees prepare for the future. Research shows that overall, 96% of workers use an employer-sponsored retirement plan to save for retirement. It can fill a critical need at a time when the vast majority of Americans haven’t saved even a fraction of what they would need to retire comfortably.

Retirement benefits are important to job seekers.

said retirement benefits are important in accepting a job .

said retirement benefits are important in staying with a job .

“Retirement Benefits, Workplace Culture Crucial to Job Seekers,” National Association of Plan Advisors (NAPA), July 2019.

Convenience

Contributions are automatically deducted from participating employees' paychecks each pay period, so they don't have to budget separately for setting money aside.

The earlier employees start saving, the more time they’ll have for their retirement accounts to grow. And any matching contributions you offer give them an opportunity to take advantage of “free money”—providing even more incentive to maximize their contributions.

Tax advantages

Employee pre-tax contributions are deducted from paychecks before income taxes, reducing taxable income. Taxes are also deferred on any investment earnings until the money is withdrawn in retirement.

Flexibility

Employees can request to take a loan from their 401(k) plan balance and select a loan repayment schedule that suits them within plan terms. You can also choose to have the plan allow for hardship withdrawals.

Financial wellness

Simply Retirement by Principal ® 401(k) plan participants will have access to a comprehensive financial wellness platform that provides tools and resources to employees to better manage their current and future financial well-being.

The earlier your employees start contributing to a 401(k) plan, the more their retirement savings could potentially add up.

As the plan administrator, you and/or a designated employee (such as a human resources manager) will have some tasks, including:

Keep employee information up to date

As employees are hired or when they leave, just provide the latest information. If you use QuickBooks ® Online, this information can automatically sync with your retirement plan.

Submit contributions each payroll

Each payroll, you’ll need to deduct employee contributions from their pay. Then, you can easily submit those contributions and any matching contributions to us via EFT from your bank account.

Approve employee withdrawals/loans

If an employee requests money out of the plan, you’ll need to approve the request.

Complete annual plan compliance activities

Plan compliance basically means that you’re following the rules. The Ubiquity Retirement + Savings ® compliance system is fully automated—you just need to answer some questions each year. We’ll then crunch the numbers and create the necessary forms for you to review and submit to the IRS.

You might find it helpful to work with a financial professional and/or a third party administrator (TPA). But if you’re not working with one, that’s okay, too. Simply Retirement by Principal ® is designed to make it easy by automating some of the paperwork and notifying you when certain actions are needed—so you can feel confident you’re staying on top of things.

Choosing investments for a retirement plan comes with a lot of responsibility. It’s called being a "fiduciary" and fiduciaries are personally liable for those choices.

Simply Retirement by Principal ® makes it easier for you with Wilshire Advisors LLC This will be the plan’s 3(38) investment fiduciary. That means Wilshire Advisors LLC will provide objective, independent third-party oversight for the screening, selection, and monitoring of the plan’s investment options. They’ll also make changes to the investment lineup as appropriate. This service will help manage your related fiduciary liability. *

Wilshire Advisors LLC is a diversified global financial services firm with more than 40 years of experience providing investment guidance to some of the largest plan sponsors in the U.S.

* You, as plan fiduciary, are ultimately responsible for the selection and monitoring of their delegated responsibilities, not by any member of Principal ® and Ubiquity Retirement + Savings ®

If you choose a 401(k) plan with Simply Retirement by Principal ® , you’ll start by answering a few questions to create a plan proposal with cost estimates. Once you complete your plan purchase, you'll be prompted to create a login and password to access the Ubiquity recordkeeping platform. Log in, provide any necessary additional information, sign required documents, and pay the one-time start-up fee of $500. Then you'll be able to start onboarding participants. Participants will receive an email to create their own login and set up their account.

Automatic enrollment

The Simply Retirement by Principal ® 401(k) plan offers the option for employees to be automatically enrolled at a default pre-tax contribution percentage set by you. Employees can change this amount or opt out at any time.

To be eligible, employees must be age 21 or older and meet the employment requirement you set, whether it's their first day of work, after three months of work, or on their first employment anniversary. If you choose the automatic enrollment option, once eligible, employees will be automatically enrolled at the default pre-tax contribution percentage you set. They’ll also have contributions directed to the plan’s qualified default investment alternative (QDIA) unless they elect otherwise. A QDIA is a default investment used when money is contributed to an employee’s 401(k) account, but the employee hasn’t made their investment election.

Don't worry—employees can change their contributions and investment election or opt out of contributing to the plan at any time. Automatic enrollment can help increase participation, simplify administration, reduce follow-up, and help your employees save for retirement.

Employee contributions

Employee contributions will be deducted from payroll each pay period. Simply Retirement by Principal ® can integrate with select payroll providers to make this process easier for you.

As you research your options and compare pricing, there are several components to keep in mind. Plan expenses are the fees you and/or your participants pay for things like initial plan setup, recordkeeping, and investment management. These are set by the organizations involved with providing services for a plan. Plan costs are any matching contributions you decide to make, which you’ll set in your plan design. In addition, if you choose to work with a financial professional and/or a TPA, there is typically a fee for their services.

Flat recordkeeping fees vs. asset-based recordkeeping fees

When it comes to plan expenses, one important consideration is whether fees are flat or asset-based.

Flat fees have two advantages. First, they’re consistent, so you can plan for them in your budget. And second, they’re typically an advertised amount that’s the same for everyone, so there’s no question if others are getting a better price.

Asset-based fees are determined by the assets in the plan, so as employees contribute and plan assets change, the fees change accordingly. When a plan is initially started, asset-based fees may appear lower than flat fees, but they can quickly add up over time.

Pricing for our solution

The Simply Retirement by Principal ® 401(k) plan has a simple flat recordkeeping fee structure.

You’ll pay as little as $145 per month ($435 billed quarterly). If you choose to pay the $6 per participant, per month fee on your employees’ behalf, this will also be billed quarterly, three months at a time. Otherwise, it will be deducted from participants’ plan assets. Custodial and investment fees are charged against participating employees’ accounts (those vary by investment and range from 0.05% – 0.91%, as of December 31, 2023 ).

Financial professional and TPA fees

If you choose to work with a financial professional and/or a TPA, they will also have a fee for providing their expertise and assistance with the setup and management of your plan. You may pay this fee directly to your financial professional and/or a TPA. Or, financial professional fees can be deducted from participant accounts. (TPA fees must be billed directly).

Ready to get started?

Try our 401(k) planner

Intended for financial professional, TPA, and plan sponsor use.

*50% of the qualifying start-up costs for a new employee retirement plan: 50% of the qualified startup costs paid or incurred, but limited to the greater of (1) $500 or (2) the lesser of (a) $250 for each non-highly compensated employee who is eligible to participate in the plan or (b) $5,000. Qualified startup costs (1) In general “qualified startup costs” is ordinary and necessary expenses of an eligible employer which are paid or incurred in connection with -- (i) the establishment or administration of an eligible employer plan, or (ii) the retirement-related education of employees with respect to such plan. (2) Plan must have at least 1 participant: would not apply if plan does not have at least 1 employee eligible to participate who is not a highly compensated employee. Information about the SECURE 2.0 Act is educational only and provided with the understanding that Principal ® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other financial professionals on all matters pertaining to legal, tax, investment or accounting obligations and requirements.

*Eligible automatic contribution arrangement: The SECURE 2.0 Act of 2019 provided an automatic enrollment one-time tax credit possible to be up to $500 per tax year for each year of the 3-taxable-year period beginning with the first taxable year for which the employer includes an eligible automatic contribution arrangement. This credit is for plans that include the eligible automatic contribution arrangement (EACA) feature only. Information about the SECURE Acts is educational only and provided with the understanding that Principal ® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other financial professionals on all matters pertaining to legal, tax, investment or accounting obligations and requirements.

*Workers are more likely to save for retirement when they have access to a 401(k) or similar plan through their employer: Principal ® Retirement Security Survey – October 2022.

As part of the Simply Retirement by Principal ® product, Wilshire Advisors LLC is the fiduciary responsible for the selection and monitoring of the investments.

Tax credit is for contributions for employees who earn no more than $100,000 (adjusted for cost of living), the credit is 100% of the contribution for the first 2 years with a 25% reduction each year, and credit can’t also be counted for the start-up tax credit.

Start-up tax credit modification: Small employers with 50 or fewer employees may apply 100% of qualified start-up costs towards the tax credit formula (up to $5,000 per year).

  • Applicable to small employers with 50 or fewer employees.
  • For employees with 51-100 employees: The credit is phased out by reducing the amount of credit each year 2% for each employee in excess of 50.

1st and 2nd year = 100%, 3rd year = 75%, 4th year = 50%, 5th year = 25%, 6th year = 0%

No contributions may be counted for employees with wages in excess of $100,000 (inflation adjusted). If taking advantage of this tax credit, employer contributions may not also be counted towards “start-up costs” in the start-up tax credit calculation.

You have a plan in progress.

Continue building your plan.

  • 401(k) for Startups – What You Need to Know

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  • Startup Finance

Last Updated: December 19, 2023 By Michaela Dale

Retirement savings plans are a major selling point for potential startup employees. One of the most commonly used retirement plans is a 401(k), which allows startup employees to contribute to their retirement and, potentially, receive contributions from their employer as well. 

If you’re considering setting up a 401(k) for your startup, look no further. We’re here to help with this guide on what you need to know about startup retirement plans and how to start a 401(k) for employees . 

How to Start a 401(k) for Employees

Starting a 401(k) for startup employees has several benefits for hiring, retention, and even taxes. However, before you set up a 401(k) for your startup, you need to determine whether it is the right time for your business to offer a retirement plan. 

Even if you decide not to contribute to your employee’s retirement account, there are still administrative fees associated with starting and maintaining a retirement plan. The first step to determining if this retirement plan is right for your startup is developing a strong understanding of what a 401(k) is, how it works, and the retirement plan alternatives available. 

In addition to this, we always recommend speaking with an attorney for tax or legal advice.

What Is a 401(k)?

A 401(k) is a type of retirement savings plan a business owner can offer eligible employees. This is an employer-sponsored investment account wherein employees are able to dedicate a portion of their salaries toward retirement. Although it is not required, employers will commonly match employee contributions to incentivize staff as well as receive a potential tax credit and tax benefits.

How Does a 401(k) Work?

When a 401(k) is offered, employees determine the amount they would like to contribute to their retirement account per paycheck. The dollar amount or percentage chosen will be automatically withheld from the employee’s paycheck. The contribution is then invested by a third-party administrator (TPA) or trustee .

The funds collected in the retirement account can be kept there until retirement age or when the employee chooses to withdraw the funds. Employees are able to withdraw the funds at any time, however, if a withdrawal is made before the age of 59 and a half, it will accrue a penalty fee for early withdrawal.

Types of 401(k)s: Pre-Tax vs. Post-Tax

The type of retirement savings plan you choose will impact when funds are deducted from your employee’s paychecks. The two most common plans are traditional and Roth:

  • A traditional 401(k) deducts funds from the employee’s paycheck before federal and state taxes are taken out. 
  • A Roth 401(k) , however, deducts contributions after taxes have been taken out. 

The key difference between the two is when taxes are taken out. With a traditional 401(k), taxes are taken out whenever a withdrawal is made. Alternatively, Roth 401(k)s are already taxed and, therefore, are not subject to further taxation during a withdrawal. 

Other 401(k) plans include:

  • Safe Harbor 401(k) plan — Opts your startup out of annual nondiscrimination testing, however, employer contributions are required. 
  • Solo 401(k) plan — This plan is only applicable if the founder and/or the founder’s spouse are the only employees. 
  • SIMPLE 401(k) plan — Designed for companies with 100 or fewer employees. This plan has lower contribution limits and no annual testing, however, employer contributions are required. 

Benefits of 401(k)s for Startups

While setting up a retirement plan like a 401(k) isn’t the right choice for every startup, there are some benefits to consider. Some of the perks related to offering this type of retirement plan for your eligible employees include tax advantages and potential increases in recruiting and retaining top talent. 

Deductibles, Tax Credits, and Tax Benefits

Matching your employee’s contributions is a deductible expense, meaning tax savings for your startup. Plus, eligible small business owners can receive a $500 tax credit for setting up an employee retirement plan for the first three years it is offered.

Tax-Free Bonuses

Retirement plans also may mean tax savings for employees as well. You can give employees a tax-free bonus by contributing to their retirement fund rather than offering a standard, taxed bonus, allowing them to keep the full amount. 

Hiring and Retention 

Retirement plans are valuable tools for hiring and employee retention as an attractive benefit of their employment as well as a signal of your startup’s financial health. 

Personal Benefits 

If you opt to deploy a 401(k) retirement plan for your startup, you can also benefit as a founder if you are eligible to contribute to your business’s retirement plan, saving you money on your personal tax returns.

How to Set Up a 401(k)

If you’ve chosen to start a 401(k) retirement plan for your startup, these are the steps you need to take to set it up, starting with choosing the right retirement plan for your startup. 

1. Choose the Type of 401(k) Plan

Your first step towards setting up your startup retirement plan is to determine the right plan for your business and its employees. There are five types of 401(k) plans to choose from: 

  • Traditional 401(k) plan
  • Roth 401(k) plan 
  • SIMPLE 401(k) plan 
  • Safe Harbor 401(k) plan 
  • Solo 401(k) plan 

Traditional and Roth 401(k) plans are the most common. However, the right retirement plan for your startup is dependent largely on the number of employees, how much (if any) you choose to match, and whether funds will be taken out pre-tax or post-tax.

2. Iron Out Policy Details

Next, you have to decide on policy details, including contribution limits, vesting information, and how much your startup will match. These policy details should be crystal clear in writing for employees opting into the 401(k). 

Contribution Limits 

This is essentially the maximum amount of funds your employees are able to contribute to their 401(k). This is especially important to determine in tandem with your matching contribution amount. 

Employer Contribution

While matching your employee’s contributions isn’t required for traditional, solo, or Roth 401(k) plans, it is a great way to attract top talent, retain employees, and show them that you care about their well-being. Plus, contributions can be written off as a business expense on your startup’s income tax return. Determine the amount your startup will be contributing, if any, and add these to your policy details. 

Vesting Information 

You should also include information about when contributions will become vested (or when employees will have access to the company’s contributions). 

3. Find a Trustee

When contributions are taken out of your employee’s paychecks, they need to be managed and accounted for to ensure they end up in the right place. To do this, your startup needs a trustee or third-party administrator (TPA) to be responsible for investing these funds. 

We recommend consulting with an Employee Retirement Income Security Act (ERISA) attorney for legal or tax advice on whether your startup should be its own trustee or outsource this role to an external company.

4. Adjust Accounting Procedures

Once your policy is set, your accountant will need to update their processes to ensure that all contributions are accounted for and in the right place. Especially if you are matching employee contributions, confirming that the financial projections and overview are accurate. 

Alternatives to 401(k) Plans

If you aren’t sure whether a 401(k) is right for your company, there are other options available to provide valuable retirement planning for your startup. Two of the most common 401(k) alternatives are SEP IRA and SIMPLE IRA:

A simplified employee pension (SEP) IRA is a retirement plan for business owners and self-employed individuals. This is a great option for solopreneurs or companies operated by a handful of co-founders, as contributions can only be made by business owners.

A savings incentive match plan for employees (SIMPLE) IRA is a retirement plan for companies with 100 employees or less. While this plan is true to its name and relatively easy to implement, it does require employer contributions.

Can startups offer a 401(k)?

Yes, startups can offer a 401(k) plan to their employees. Early-stage startups, however, may not offer 401(k)s or other retirement plans as their capital is limited at this stage and used primarily for scale. In lieu of this, many startups choose to offer profit-sharing plans instead.

What is the average 401(k) match for startups?

On average, companies match between 4% to 6% of an employee's salary or $0.50 on the dollar. However, this varies from company to company. 

How much does it cost an employer to set up a 401k?

The cost of setting up a 401(k) is dependent on the size of the business and its staff. However, setting up a 401(k) could cost your startup between $500-$2,000. 

Can you set up a 401k for one employee?

Yes, you can set up a 401(k) for one employee if you only have one staff member. If you have more than one employee, you can only exclude employees from a 401(k) plan if they have not reached the age of 21, have not completed a year of employment at your company, or “are covered by a collective bargaining agreement that does not provide for participation in the plan, if retirement benefits were the subject of good faith bargaining,” according to the Internal Revenue Service . 

How many employees do I need to set up a 401k?

You can set up a 401(k) no matter how many employees you have. In fact, the SIMPLE 401(k) plan is built for businesses with 100 or less employees. However, it does require employer contributions. 

Additionally, you can set up a 401(k) without any employees. A Solo 401(k) plan is a great option for business owners as well as their spouses to reap the benefits of a 401(k) without employees.

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The Complete Guide To Choosing, Setting Up & Maintaining A Company Retirement Plan

Every single thing you need to know to get your company retirement plan up and running

Start by thinking about your intentions, rather than different types of retirement plans.

Finding the best retirement plan for your business has everything to do with your goals. The very first step you should take is to identify what you are trying to accomplish with the plan. If you’re unsure of your goals, but just know you need a plan, ask yourself the following questions:

  • Is the priority to maximize the funding of your own retirement account?
  • Are you focused on attracting and retaining top talent by offering a competitive retirement plan?
  • Are you looking to reward certain employees more than others?
  • Are you looking to offer a vehicle for your employees to save for their retirement, even if you are unable to provide any funding at this time?

Business Owners Need Trusted Retirement Plan Support

Find a third party retirement plan administrator (tpa) you can trust..

Whether you’re developing a new plan or switching administrators, your TPA should make sure everything is taken care of and the plan is designed to fit your needs. This allows you to focus on running your business.

Your retirement plan TPA should stand shoulder-to-shoulder with you throughout the life of your plan to ensure you properly attend to your fiduciary duties and that you, your business , and your employees continue to receive maximum benefit from your business retirement plan. As part of your qualified retirement plan design, your plan administrator will help you:

  • Choose the plan that is right for you
  • Draft the plan documents and set up the plan
  • Prepare notices for your employees letting them know how to participate
  • Perform annual testing to make sure the plan is compliant
  • Process plan distributions and loans
  • Amend the plan when legislation requires it or when the needs of the company change
  • Make sure you are getting the most out of the plan

At the end of the year, your dedicated administrator needs to take the time necessary to perform a  thorough evaluation of your plan’s overall health so you have a clear understanding of your plan’s status. You have enough to worry about—let your TPA help get your retirement plan in shape.

You Have Options Beyond 401(k) or Safe Harbor 401(k) Plans

Understand that you have options..

Some 401(k) TPAs may suggest cookie-cutter plans that are easy to establish and administer. Look for an administrator that will provide a comprehensive analysis of available options and are able to identify enhancements and additional benefits over and above these plans in many cases.

The reasons why you’ve decided to set up a retirement plan for your company will determine which plan is best for you and which features you'll want to include. It doesn’t matter if your main goal is to put away money for yourself, reward top-performing employees, or be more competitive in recruiting employees, your retirement plan TPA will help design a plan in line with your intentions.

Many business owners enter the conversation having done some research and have an idea what their plan should look like, but that research is unlikely to include detailed information customized to you and your business. That’s why a good TPA will work with you to create a custom plan designed to meet your goals and build successful outcomes for everyone at your company. You can explore options customized for you and your business needs, with considerations like:

  • Waiting periods for employee and employer contributions, entry dates, and employee classifications
  • Excluding bonuses, overtime, commissions, or fringe benefits in the formula for computing contributions
  • Provide contributions only to full-time employees who don't quit during the year
  • Tiered allocation and age-weighted formulas instead of basic pro-rata contributions

Having flexibility with respect to your plan design is the difference between a retirement plan that works and one that works for you. While your company may already offer a plan to your employees, could it be better or offer more flexibility for what you want the plan to provide?

Compare Plan Types

Wondering what the difference is between a 401(k) and a 403(b)? Confused about Safe Harbor 401(k)? And what is prevailing wage? Comparing retirement plans can be complicated, so we’ve rounded up the need-to-know information to get you started.

we’re here to help when you are ready

401(k) Plan

Description:.

A type of qualified defined contribution plan that permits employees to elect to defer compensation into the plan on a pre-tax (or in the case of Roth contributions, post-tax) basis. An account is maintained for each participant, and the retirement benefit is based on the account value at retirement. The retirement benefit will vary depending on the engagement of both employee and plan sponsor as well as market performance.

  • Allows employees to elect to contribute to their retirement via payroll deductions.
  • Allows employers to make match or non-elective profit sharing contributions.
  • Employer contributions are tax deductible up to 25% of total eligible compensation.
  • Allows flexibility with employer contributions, employers may elect to have discretionary or fixed contributions.
  • Employee contributions and earnings are tax deferred until distributed at retirement (except in the case of Roth contributions).
  • 401(k) plans are an extremely valuable employee benefit. To compete for talent, a 401(k) is expected. Having a plan that only offers employee contributions is better than having no plan at all.

Considerations/Limitations:

There are two tests that may complicate this plan design:

  • Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests. In this test you divide the company into two groups – highly compensated employees (owners and non-sibling family, or those earning over $120,000 in 2017), and non-highly compensated employees (everyone who isn’t HCE). The people in the HCE group can defer or receive match contributions an average of 2% more than the average of the people in the NHCE group in most cases (when NHCE average is between 2 and 8%). This restricts the average amount the HCE group is allowed to defer. This test can be corrected with additional employer contributions or a distribution of HCE deferrals and/or match contributions in excess of the acceptable amount.
  • Top Heavy test. If more than 60% of the plan assets are in the accounts of the business owner, non-sibling relatives of owners, or certain officers of the business, then the plan is considered “top heavy.” In general, when the plan is top heavy in the prior plan year, the employer must make a minimum contribution of 3% of pay to each of the eligible employees.
  • Companies already passing or very close to passing the ADP test.
  • Companies trying to benefit targeted HCEs over other HCEs.
  • Companies that can’t afford to allow for mandatory safe harbor contributions.
  • Owner-only or NHCE-only plans.
  • Companies whose primary reason for installing the program is access to a 401(k) for employees.
  • Companies whose primary reason for installing the program is to create a qualified trust for prevailing wage contributions.

401(k) Safe Harbor Plan

401(k) Safe Harbor plans are simply 401(k) plans that have adopted the safe harbor provision which provides an automatic “pass” to each of the ADP/ACP and top-heavy tests referenced above. This allows for owners and other HCEs to defer to the annual maximum each year regardless of average employee participation and a guaranteed pass on the ACP test for match formulas considered “safe harbor” (e.g., 100% match on deferrals up to 4% of compensation). Safe harbor plans require mandatory employer contributions each year.

  • Allows employees to make contributions to the plan via payroll deduction.
  • Allows HCEs to defer up to the 402(g) annual deferral limit each year.
  • Employer contributions are tax deductible up to 25% of eligible employee compensation.
  • Employee contributions are tax deferred until distributed at retirement (except in the case of Roth contributions).
  • Allows access to discretionary employer match and/or profit sharing contributions.
  • Mandatory annual safe harbor contributions to the plan. These may be 3% of compensation for each eligible employee (safe harbor non-elective) or as low as 4% of compensation for employees who choose to make 401(k)/Roth deferrals of at least 5% of compensation (safe harbor match).
  • Safe harbor contributions must be immediately 100% vested.
  • While the top-heavy test is deemed to pass which prevents the requirement of corrective minimum contributions due simply to deferrals, additional profit sharing contributions negate this automatic pass and safe harbor match plans may require additional contributions to employees who choose to not defer.
  • New plans with owner and/or HCE interest that expect little to no voluntary employee participation.
  • Existing plans with excessive corrective distributions or unaffordable corrective contributions.
  • Family businesses.
  • Current sponsors of a SIMPLE 401(k) who would appreciate an increase of deferral limits to $18,500 in 2018 from $12,500.
  • Plans with a large discrepancy between owner and staff compensation.
  • Companies that would like to attract talent with the promise of annual contributions to their retirement account.

403(b) Plan

A type of plan similar to a 401(k) plan, this plan type is only available to certain entities, including non-profit organizations under IRC 501(c)(3), and public educational and church organizations. The plan permits employees to defer compensation into the plan on a pre-tax (or in the case of Roth contributions, post-tax) basis.

  • Allows employees to elect to defer contributions.
  • Employer contributions are tax deductible up to 25% of eligible participants compensation.
  • Employee contributions are tax deferred until taken out at retirement (except in the case of Roth contributions).
  • Salary deferrals are not subject to compliance (ADP) testing.
  • Certain plans may not be subject to ERISA.
  • There is a Form 5500 filing requirement for 403(b) plans that have employer contributions.
  • It is sometimes difficult to round up investment reports from each of the individual accounts to prepare the filing.
  • 403(b) plans are either subject to ERISA (retirement plan rules), or not. Church plans covering employees of the church, and plans that have no employer contributions, are typically exempt from ERISA.
  • A non-ERISA plan is not subject to testing or filing requirements.

Non-profit entities that will make no employer contribution, but who want the employees to have access to a retirement plan.

Profit Sharing Plan

A defined contribution plan under which the employer may determine, annually, how much will be contributed to the plan. However, regular contributions must be made to the plan to avoid IRS scrutiny. The plan details a formula for allocating to each participant a portion of each annual contribution, though the actual contribution amount may be fixed or discretionary. Profit sharing plans may exist in a trustee-directed, single, pooled trust account or in participant-directed individual accounts or both. Participant deferrals are typically placed in individual accounts. All 401(k) plans are profit sharing plans but not all profit sharing plans contain 401(k) or match contribution provisions.

  • No additional payroll procedures to implement if no 401(k) provision.
  • Gives employers simplicity in plan design and discretion over annual contributions.
  • Provides benefits to a mix of rank-and-file employees and owner/managers.
  • Contributions and earnings generally are taxed upon distribution.
  • Retirement plans funded only with profit sharing contributions can be an expensive way to get the maximum annual contribution to targeted employees.
  • It can be frustrating for employees if they are not allowed access to payroll deferrals through a 401(k).
  • Companies simply looking for the tax advantages of a retirement plan without the burden or liability of additional payroll processes as a result of a 401(k) provision.
  • Companies with a SEP looking for more flexibility with eligibility and distribution requirements and/or increased HCE favorability with contribution allocations.
  • Owner or family-only companies.
  • Companies who would like to attract talent with the promise of annual contributions to their retirement account.

Cash Balance Plan

A cash balance plan is a defined benefit plan with defined contribution characteristics. Similar to defined benefit plans, a cash balance plan promises to pay employees a certain amount of income at retirement via mandatory annual contributions. The risk of investment lies with the employer, and the plan is likely subject to Pension Benefit Guaranty Corporation (PBGC) oversight and fees. Like defined contribution plans, participant “accounts” are represented as dollar amounts so the benefit is easy to understand and there is a direct relationship between the contributions made currently and the promised benefit at retirement.

  • Cash balance plans provide the advantages of a pension plan, but they are much easier to explain to employees. While benefits are still provided as they would be under a defined benefit plan, the cash balance participant has a “hypothetical account” which is equal to the “pay credits” and “interest credits” they have earned over their participation in the plan. This contribution formula also allows the employer greater predictability for the contribution, making it an extremely valuable tax planning tool.
  • Contributions may be vested over a 3-year period from the inception of the plan.
  • Deductibility of a defined benefit plan combined with the accessibility and effectiveness of a defined contribution plan.
  • Contributions are required every year for at least three years (five is preferred) and, while providing a large benefit to a select few, may be very large.
  • 40% of employees working at least 20 hours per week or salaried must be covered by the plan.
  • If the investment portfolio does not return the rate defined for the “interest credit” then the contribution may have to be increased to make up for the shortfall; similarly, any rate of return that exceeds the prescribed amount results in a reduced contribution, thus tax deduction for that year.
  • Actuarial calculations are required annually to determine the pay credit, interest credit, and additional portfolio adjustment contributions required.
  • Changes to the company’s demographics may impact the funding formulas. Speak with your administrator before the end of the first quarter of the plan year to discuss what important amendments should be adopted to avoid unintentional contributions to terminated staff or failure to meet minimum coverage requirements of new staff.
  • For cash balance to provide larger contributions to targeted employees, they must be combined with 401(k) profit sharing plans (called “combo” plans). This will require two separate documents, a series of compliance tests, and filing requirements so costs roughly the same as two plans to administer.
  • PBGC premiums run about $74 per person in 2018 and are due 9 ½ months after the start of each plan year (10/15 for calendar plans). Professional services companies such as architects, engineers, attorneys, and doctors with less than 25 participants are exempt from PBGC.
  • Considering the setup fees, TPA fees, actuarial fees, and PBGC premiums it had better be worth the increased tax deduction considering the new costs. When it works, it works.
  • Small- to medium-sized companies that are looking to make significant contributions toward retirement for business owners and/or key employees in their mid-forties or older. In many instances, when paired with a 401(k) profit sharing plan, targeted individuals can get contributions of $100,000–$260,000 per year while contributions to employees may be as low as 5% of pay per year.
  • Partners or owners who desire to contribute more than $50,000 a year to their retirement accounts.
  • Companies that have demonstrated consistent profit patterns. Because a cash balance plan is a pension plan with required annual contributions, consistent cash flow and profit is very important.

Partners or owners over 45 years of age who want to accelerate their pension savings. The older the participant, the faster they can accelerate their savings.

Defined Benefit Plan

A defined benefit plan promises to pay employees a certain amount of income at retirement. Contributions are made by the employer on a pre-tax basis and are intended to grow so there will be adequate funding at retirement. Employer contributions are based on a benefit formula stated in the plan that must be calculated by an actuary. In a defined benefit plan, the risk of the investment lies with the employer, as no matter how much the employer contributes, a participant is still guaranteed a specific retirement benefit. Defined Benefit plans are also subject to PBGC oversight and fees in most cases (see Cash Balance plans above for more information.

  • The annual contributions are often significantly higher than with defined contribution plans, like 401(k) plans. Since contributions to qualified retirement plans are tax deductible, a defined benefit plan can prove to be a good tax-planning tool.
  • Increased employer contributions compared to a defined contribution plan.
  • Defined benefit plans require the services of an actuary to determine the contributions required each year.
  • Contributions to the plan are required every year. A minimum number of employees must be funded, so a company needs to budget carefully and plan at least five years ahead. The rate of return that the portfolio provides is defined in the plan document. If the portfolio fails to return that rate, then additional contributions may be required to make up for the shortfall. Conversely, if the portfolio return exceeds the assumed plan rate, then contributions may be reduced resulting in possible tax planning challenges.
  • Small successful companies with predictable cash flow, and few employees who are not owner or family.
  • Owner-only companies where the owner is older than age 45 with predictable cash flow who want to contribute more than $60,000 to their retirement.

A defined contribution plan that invests primarily in company stock. An ESOP provides liquidity for shareholders that isn’t available for most non-publicly traded companies. It can be structured to provide a tax-advantaged transition of shares from a selling shareholder to the employees of the company.

  • Employer tax deduction on contributions of cash or stock to the plan.
  • May be used to acquire shares from selling/retiring shareholder.
  • Employees become owners of the company through the plan.
  • Employees recognize that they benefit directly from the success of the company.
  • Plan trustees vote shares held by the plan, with certain exceptions, so there is no loss of control.
  • S-Corporations that are 100% ESOP owned will have no corporate income tax since the shares are owned by a tax-exempt trust.
  • Shares purchased with a loan guaranteed by the corporation will have an impact on the company’s balance sheet.
  • Stock must be valued by an independent appraiser at each transaction, and annually.
  • The plan invested primarily in company stock, so success of the plan depends heavily on the success of the business.
  • Employees who terminate service may be able to request a distribution in the form of shares.
  • Most terminated employees will ask to sell their shares back to the plan or to the company resulting in a need for liquidity within the plan.
  • A business owner planning for retirement in the next five to ten years. He or she can continue to manage the company even after selling shares to the ESOP.
  • If 30% or more of the shares are sold to the ESOP, the selling shareholder may be able to exchange company stock for a portfolio of publicly traded stocks. The §1042 exchange provides favorable tax treatment on the sale of stock.
  • Companies whose employees are interested in an ownership stake in the company.

Cafeteria Plan

An employee benefit plan that allows pre-tax contributions to fund benefits such as insurance premiums, dependent care, and/or uninsured medical expense reimbursement.

  • Premium only plans allow for the employees to pay their expenses on a pre-tax basis.
  • Dependent care expenses of up to $5,000 per year can be paid with pre-tax funds.
  • Medical expenses that are not covered by insurance can be paid on a pre-tax basis. This is great for expenses like chiropractic, dental work, and large co-pays.
  • Employer saves employment taxes on cafeteria plan contributions.
  • Reduces workers’ compensation premiums.
  • Dependent care and reimbursement accounts are use-it-or-lose-it. If the employee fails to remit reimbursement requests during the year or within the first 2½ months of the following year, funds are forfeited and remain in the company’s cafeteria plan account.
  • Compliance testing is required. Contributions from key employees cannot represent more than 25% of the total premiums or total reimbursement contributions. For dependent care, the contributions from the key employees cannot exceed 50% of the total dependent care expenses.
  • Companies that pass some of the insurance premium expense to their employees can at least offer a tax-favored way for the employee to pay those premiums.
  • Insurance coverage for dependents can be paid with pre-tax dollars.
  • If employees have a lot of out-of-pocket medical expenses, or dependent care expenses the plan can provide some relief.

457(b) Plan

A 457(b) plan may be adopted by §501(c)(3) non-profit entities. A 457(b) is often paired with a 403(b) or 401(k) where the executive director or management team is restricted from making maximum contributions to the existing plan. The 457(b) plan may be funded by the employee or the employer or both.

  • Allows employees to elect to defer contributions via payroll deduction.
  • May provide a benefit to certain highly compensated employees of tax-exempt, non-government agencies.
  • These are considered “top hat” plans as eligibility is restricted to a select few employees of the company. There is an initial disclosure that must be submitted to the Department of Labor, but no other filings are required.
  • A plan document is required for the 457(b) plan. Any changes to the group of employees eligible for the plan must be changed through plan amendment.
  • 457(b) plan assets are considered assets of the employer, not of the individual for whom the contributions are made. Accounts may be set up on behalf of the employees, but are subject to creditors of the employer unless the plan is set up through a rabbi trust.

Non-profit entities whose executive director or management team is looking to increase contributions above and beyond what is available to them through the 401(k) or 403(b) plan sponsored by the employer.

Prevailing Wage

Many companies will choose to satisfy some or all of the prevailing wage law requirements by contributing that amount to a benefit plan (like a profit sharing plan) on behalf of the employee, rather than paying it to the employee in cash. If the contractor pays the fringe as compensation, the payment is subject to FICA and other payroll taxes. However, by contributing the fringe to a benefit plan, it is not subject to taxes.

  • Savings in payroll taxes.
  • Lowered workers’ compensation premiums (since the fringe benefits are not considered part of the payroll).
  • Flexibility for company to deduct contributions to a tax-deferred plan for key employees with little or no contribution required for other employees.
  • Can be combined with a 401(k) plan to allow both field and staff employees to reduce personal income taxes by contributing a portion of their gross paycheck on a pre-tax basis to a retirement plan with tax-deferred earnings.
  • Some employers with existing safe harbor 401(k) profit sharing plans may want to consider utilizing the prevailing wage fringe to offset the required safe harbor contribution.
  • Special consideration needs to be given to such plan design features as eligibility requirements, service crediting method, vesting, timing of contributions and the treatment of forfeitures.

Any open-shop contractor that intends to continue to pursue public works projects and is looking to bring their labor rate down by reducing their taxable liability.

In a rollover business startups (ROBS) plan, rollover money is used to buy stock for a business venture, startup or existing. With an individual account, the individual may elect to invest up to 100% of their account in the form of employer stock. By rolling cash into the plan, then using that cash to buy company stock, the cash is freed up to help with business expenses.

  • Provides an opportunity for entrepreneurs to use their retirement savings to invest in themselves.
  • Avoids immediate taxation on retirement plan funds.
  • Provides funding for the new company, regardless of your credit rating or any other factors.
  • There is no debt to repay or interest payments to make.
  • Afford to re-invest more profits back into the company.
  • Plan is available to C-corps only.
  • If the business fails, your retirement savings are at risk.
  • While the IRS has concluded that ROBS are not abusive tax avoidance transactions per se, they can be disqualified if they are not properly administered.
  • Available stock must be offered to all eligible plan participants.
  • Annual independent valuation of company must be performed.

C-corporations looking for more capital to fund their business ventures whose board is comfortable with making company stock available to all members of the retirement plan.

Who will be involved with the plan set up and maintenance?

Learn more below about the different service providers and the role each plays in keeping the plan a success.

Key Players in a Retirement Plan

1.) a plan sponsor (that's you or your client if you are a financial advisor).

The company that offers the plan for their employees is considered the Plan Sponsor. When starting a retirement plan everything with respect to the design of the plan should revolve around what the Plan Sponsor's needs are. Ultimately the day-to-day responsibility for the Plan lies with the sponsor, but a good TPA will help you with these responsibilities:

  • Enroll eligible employees
  • Deposit contributions to the plan
  • Authorize of benefit payments
  • Confirm compliance
  • Submit annual government filings

Plan Sponsors rely on the assistance of professionals to help them fulfill their responsibilities. Those various providers are described below.

2.) A FINANCIAL ADVISOR

The financial advisor is a person or company that helps you select the right investment mix and provider for your plan. A responsible advisor will perform some of the following functions:

  • Prepare an Investment Policy Statement
  • Help select the investments available within the plan
  • Monitor the investments regularly
  • Meet with the Plan investment committee at least once per year

Provide information and education to employees about the Plan and investment strategies

3.) AN INVESTMENT CUSTODIAN

Investment Custodians hold the money for the Plan and its participants. Custodians perform a variety of functions for a Plan including some or all of the following:

  • Post investment trades
  • Allocate dividends and fees
  • Provide recordkeeping services
  • Maintaining a website for Plan participants to get information about their account

Prepare statements for the Plan and/or the participants

4.) A TPA (Third Party Administrator) - That's what we do.

An independent TPA assists the Plan sponsor in meeting their responsibilities for setting up and administering the plan. We will design the plan around your needs, set it up and maintain it. Just like a good CPA helps you follow tax law, a good TPA helps you follow ERISA laws. The TPA reviews activity during the year to confirm that the Plan Sponsor followed the rules and regulations including: 

  • Follow and maintain the Plan documents
  • Perform testing of the plan to confirm that all compliance rules are met
  • Prepare required government filings and reports to be filed
  • Answer questions from the Plan Sponsor throughout the year

We are the premier online 401k company, we answer the phone and know our clients by name, not account number.

5.) A CPA (Certified Public Accountant)

Plans with more than 100 eligible Participants must have the Plan’s financial statements audited by a CPA each year. Auditors have very specific guidelines, and they provide a valuable service to the Plan Sponsor to confirm eligibility, payroll deposits, posting details and the like. They confirm that the correct data is being provided to the TPA for testing purposes, that the investments are being reported accurately on the financial statements and reports being provided to the government.

Overview of Retirement Plan Set Up

CHOOSE PLAN DESIGN AND DOCUMENTS - design options are listed below, but if you'd rather just have someone walk you through each of these one the phone with you, request contact here for personalized help deciding on these options.

Once you have outlined your goals for what the plan will look like, you can figure out how to have your retirement plan set up to fit your needs.  Even prototype plans offer options for employers to draft a semi-custom document:

  • Waiting period – How long does an employee need to wait before he or she becomes eligible for the plan?  You can offer immediate entry or require up to a one-year wait for 401(k) plans. 
  • Age – You can require that an employee be 21 years old before they are eligible for the plan.  Any age below that is allowed as well; it’s up to you!
  • Open enrollment periods – When will an employee be allowed to enroll once they have satisfied the waiting and age requirements?  Options include immediate, monthly, quarterly, semi-annually, or annually.
  • Contributions – 
  • Will the plan include the option for employee contributions?  Will you include a Roth (after-tax) option in addition to the pre-tax option?
  • Will you fund a matching contribution?  If so, will you have a fixed formula or leave the decision about the amount until the end of the year?
  • What about profit sharing?  There are a variety of allocation formulas available.  Given your goals, which one is right for you?
  • You may wish to include a pension plan to maximize the amount of employer contributions that can be deposited to retirement accounts each year.
  • Vesting – Will employer contributions be subject to a vesting schedule?  Vesting options range from 100% immediate vesting to three-year cliff vesting (0%, 0%, 100%) to six-year graded vesting (0%, 20%, 40%, 60%, 80%, 100%). 
  • Forfeitures – Employer contributions are forfeited by employees who are not fully vested. Forfeitures can be used to pay fees, offset employer contributions, or allocated in addition to employer contributions.
  • Retirement age – At the plan’s defined Normal Retirement Age (NRA), a participant becomes 100% vested in all accounts.  NRA can be a specific age such as 59 ½, 62, or 65 or have a qualifier; for example, age 65 plus five years of participation.
  • Distribution options – Will the plan only offer lump-sum distribution?  Would you like the plan to offer installment payments and/or annuity benefits as an option?  What about loans or withdrawals due to financial hardship?
  • Compliance testing options – All plans are subject to compliance testing, but many tests have alternatives available:
  • 401(k) non-discrimination can use either prior-year or current-year testing methods
  • 401(k) testing can be avoided if Safe Harbor contributions are offered
  • Definition of Highly Compensated Employee can be limited to the top 20% of employees
  • Top-heavy contributions can include or exclude Key Employees

Get your Free Consultation to see which type of plan would be best for you! Not only will you learn how to set up a 401k, we will walk you through each step.

CHOOSE AN INVESTMENT MANAGEMENT COMPANY

Retirement plan assets are held in a trust.  The trust language is part of the plan documents.  When you have a retirement plan set up, where you choose to invest those trust assets depends on what’s important to you and the plan design.  A variety of investment custodians are available depending on which type of investment works best for your plan:

  • Trustee-directed – The plan trustee can take responsibility for investing trust assets.  The trustee may have additional exposure to fiduciary liability and responsibility if all plan investment responsibilities are assumed.
  • Participant-directed – Plan trustees can push most of the fiduciary responsibility for making investment choices to the plan participants if participants are allowed to invest funds in their own accounts.  A series of rules surround this option – see ERISA §404(c) for details.

CHOOSE YOUR RECORD-KEEPER

The record-keeping function will be determined once the investments are in place. The investment custodian, plan administrator, or a third party recordkeeping firm may be engaged to perform this function.

All investments held by the trust will need to be valued at least once per year.  Marketable securities like stocks, bonds, and mutual funds are valued by the markets in which they are traded. Fixed assets and collectibles held by trust assets need to be valued by an independent third-party appraiser every year.

The record-keeper will track account balances for the plan and/or the plan participants. Participants must be provided with a statement of their account balance at least once per year.  If the accounts are participant-directed, quarterly statements are recommended.

CHOOSE A THIRD PARTY ADMINISTRATION COMPANY - This one is easy, you are already here, and we can help you with every step listed above.

Part of getting a retirement plan set up is administration of the plan, which is the responsibility of the employer who adopted it.  Many of these functions are often outsourced to a Third Party Administrator (TPA).  The Employer should take care in engaging a TPA that will perform the responsibilities with diligence and care. As the employer, you should make sure to review the TPA service agreement so you understand completely your responsibilities and what the TPA is responsible for.

Among the responsibilities of the administrator are:

  • Plan document drafting and maintenance
  • Compliance testing to ensure all rules and regulations are being followed
  • Preparation for reporting of annual plan activity to government agencies

Work carefully with your TPA to make sure all functions are performed to your satisfaction and in a timely fashion.

How to Maintain the Retirement Plan Through the Year

You will be processing distributions and loan requests for participants in the plan.  Our role as TPA is to review the vesting and eligibility for distributions to avoid problems, or money being paid inappropriately.

At the end of the year, we’ll ask you for information about your employees and the deposits made to your plan.

As your TPA, we will perform the compliance tests, prepare financial statements, and draft the Form 5500 filing that must be submitted to the Department of Labor each year.  Keep reading for the critical due dates for retirement plans.

COMMUNICATIONS – There are a variety of notices to provide to the employees eligible for the plan.  In addition to information about the Plan and Enrollment, certain plan features such as Safe Harbor, Automatic Enrollment, and default investments must be provided annually.  At Benefit Resources, we provide assistance in preparing and reminding you about notices that are required.

Our industry is full of deadlines.

FIXED DATES

Some due dates are fixed, meaning that they always happen on a particular date every year.  Examples of fixed dates are:

ROLLING DATES

Most dates relating to due dates for retirement plans are dependent on the Plan Year.  The majority of plans are administered on a calendar year, but a good portion is administered on a fiscal year.  Very often if the company that sponsors a plan has a fiscal year, then the plan may be run on that same fiscal year.  A list of the rolling due dates for a retirement plan is shown below.  All dates relate to the end of the plan year.

We encourage all of our clients to have these due dates on their calendar, with a reminder at least 30-days in advance.

  Not sure you are getting what you need from your TPA? (An indication is that you are here rather than on the phone with them.) We can look at your latest 5500 and give you insight.

 CORRECTIONS

There is a way to fix the problem of failing to meet a deadline as outlined here. 

As your Third Party Administrator, we will work with you to make sure you get us your work on time.  Given the way that our industry is wired with due date after due date, we want to make sure that you are in compliance at all times. 

Here's what we do throughout the year to keep our clients in compliance:

  • Calculate contributions for each eligible Employee
  • Calculate maximum deductible employer contributions
  • Perform all mandatory compliance testing
  • Compare transactions processed by the retirement plan provider with client records
  • Reconcile Trust accounts and prepare financial statements
  • Prepare annual administrative reports
  • Prepare government filings: Form 5500 and related schedules
  • Prepare statements and Summary Annual Reports for Participants
  • Prepare Employee communications
  • Determine eligibility for participation
  • Determine Highly Compensated and Key Employee status
  • Prepare participant notices

Ready to get your retirement plan in place?

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Family business magazine january/february 2024.

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As a family business owner, you know that setting up a retirement plan for your employees is one of the best ways to attract and retain top talent. But not all retirement plans are created equal. While business owners can set up plans directly with one of the major financial services firms, their financial advisers or family offices are often in a better position to evaluate not only which types of plans work best for the business, but also how those plans play a role in family wealth planning.

While setting up a retirement plan such as a 401(k) has gotten easier, there are important differences among plan types. If you’re expecting one of the big brokerage firms to answer your questions, you may be at the mercy of a call center.

The first discussion with an adviser regarding defined contribution plans will likely focus on the options available to you. Here are three of the most common:

Traditional 401(k) . For 2023, employees enrolled in a traditional 401(k) program can contribute a maximum of $22,500. This figure increases to $30,000 for individuals over age 50. As an employer, you are eligible to receive up to $16,500 in tax credits over the first three years of a plan’s implementation. Additionally, 100% of employer matching contributions are tax deductible to a business, as long as contributions don’t exceed 25% of an employee’s annual income. That means an employer can reduce their taxable income dollar-for-dollar in the year they are made.  

In addition to traditional 401(k) plans, businesses may want to consider offering their employees Roth options, which enables highly compensated employees to bypass income limitation restrictions on traditional Roth IRAs.

401(k) with Profit Share. Employers that offer a 401(k) with profit share can nearly triple their maximum annual contribution from $22,500 (or 30,000 for individuals) to $66,000 (or $73,500 for employees age 50+). As with traditional plans, 401(k) with profit share plans provide owners with savings via tax credits and by allowing them to fully deduct the cost of employer matching contributions. The 401(k) with profit share plan is especially popular for Solo 401(k) businesses, where the owner is the only employee. 

401(k) with Cash Balance. Especially appealing to small-business owners or highly compensated professionals such as law firms, doctor’s offices and financial/accounting firms, the 401(k) with cash balance provides the option to pay out in a lump sum or via a monthly annuity. It also offers substantial tax-deferred savings, with annual savings of up to $330,000 per individual, depending on age.

Setting up a retirement plan requires thoughtfulness and strategy. With planning, your business will benefit.

About the Author(s)

Andrew Mescon is chief executive officer of Ballast Rock Private Wealth.

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How Do 401(k)s Work? Frequently Asked Questions

setting up a retirement plan for your business

If you're like most Americans, when you think ''retirement planning,'' you first turn to the 401(k) plan offered by your employer. After all, it's the most common type of retirement plan out there. However, 401(k) plans can be complex, and it's not always easy to understand exactly how these plans work. 

So, what are some important things to know about a 401(k)? We've got answers to many common 401(k) questions.

How does a 401(k) work?

A 401(k) is a tax-advantaged retirement plan that is set up and managed by an employer. Basically, you put money into the 401(k) where it can be invested and potentially grow tax free over time. In most cases, you choose how much money you want to contribute to your 401(k) based on a percentage of your income. Your employer automatically withholds a portion of each paycheck and puts it into the account.

With a traditional tax-deferred 401(k) , this money is taken out of your paycheck before federal income taxes are figured, providing you the chance to reduce your taxes today. You pay ordinary income taxes on the pre-tax contributions and growth when you make a withdrawal in retirement. Note: You must be older than 59 1/2 (age 55 if you separate from your current employer) to avoid penalties on withdrawals .

Some employers offer a Roth 401(k) . Contributions to these plans are made with after-tax money, which means you don't get a tax deduction. Instead, your money can potentially grow tax free and be withdrawn in retirement without any taxes. Note: To avoid penalties and/or taxes on withdrawals, you must hold the account for at least five years and be older than 59 1/2 (age 55 if you separate from your current employer).

In both types of plans, you typically have a separate account in the 401(k) registered in your name, and you'll get regular statements. Generally, you can choose from a range of investments to fit your risk tolerance and time to retirement. Each 401(k) plan tends to offer different investments, as well as whether you must pick your own investments or choose to have your account managed for you.

How much can I contribute to my 401(k)?

Your contribution to a 401(k) depends on the limits set by the IRS each year. The IRS looks at inflation to determine the annual contribution limits. For 2024, the employee deferral limit is $23,000. For those 50 or older, the IRS allows ''catch-up'' contributions of up to $7,500, for a total contribution of $30,500. 

It's a good idea to review the contributions you set up on your account annually, to ensure you’re putting away as much as possible.

How does 401(k) matching work?

One of the most important aspects of a 401(k) is the matching contributions your employer can make to your account. It’s basically a "free" contribution.

Typically, employer matching contributions are based on a percentage of the contribution you make and a percentage of your wages. For example, let's say you earn $6,000 per month, and your employer matches 50% of your contributions up to 6% of your wages. If you wanted to get the full match, you'd need to contribute at least $360 per month (6% of your monthly wages) to your account, and your employer would kick in an additional $180 (50% of $360) to match your contribution. As a result, your retirement account would see a combined contribution of $540 per month.

A common 401(k) question about employer matching is whether employer match counts toward your annual contribution limit. The good news is that it doesn't. However, there's a separate limit that affects overall contributions to your 401(k). For 2024, the combined contributions you and your employer can make to the account is $69,000 ($76,500 if you're 50 and older and making catch-up contributions). Of course, the maximum contribution can never exceed 100% of your compensation from the employer.

What is 401(k) vesting?

One of the most important things to understand is how 401(k) vesting works. Vesting is a term that describes how much of the money in your account is actually yours if you were to leave the company or take a distribution.

The contributions you make yourself are immediately vested and considered yours. However, in some companies, matching or other employer contributions aren't considered yours until you've remained with the company for a set period of time. So, if the company has a vesting schedule, you might not be able to keep all the money your employer invests on your behalf until after you've stayed at the company for the required time frame.

What happens if I make a 401(k) early withdrawal?

Generally, if you take money from your account before you reach age 59 ½, you'll have to pay taxes on the amount, plus pay a 10% penalty to the IRS. But there are some exceptions to the early withdrawal penalty.

One exception is known as the Rule of 55—if you lose (or leave) your job at age 55 or older and take distributions from the 401(k) associated with your most recent job, you won't have to pay the 10% penalty. Some other circumstances that might allow you to avoid the 10% penalty include:

  • Certain qualified birth or adoption expenses
  • A series of substantially equal payments
  • Permanent disability

You might have to provide documentation to avoid penalty in these cases, so make sure you're prepared to do so. To learn more about the exemptions to the 10%, see the IRS website.

Can I contribute to an IRA and 401(k)?

Yes, it's possible to contribute to both a traditional individual retirement account (IRA) and a 401(k). However, if you’re eligible to contribute to a 401(k), then your IRA tax deduction may be limited, but your IRA contribution will not. Whether you actually contribute to the 401(k) is irrelevant—merely being eligible for a 401(k) means you'll have to review your modified adjusted gross income to determine if your IRA contribution is eligible for a tax deduction. But the IRA contributions you make won’t affect your 401(k) contributions. Check out IRS Publication 590-A for an explanation of the IRA deduction rules.

How much should I contribute to my 401(k)?

How much you should contribute to your 401(k) depends on your retirement goals and how much you hope to amass in your nest egg by the time you retire. While you don't have to contribute the maximum allowed by the IRS, it's worth noting that the more you invest now, the more of a head start you'll likely have toward a comfortable retirement.

If you have more questions, be sure to ask a tax professional or financial advisor for more information about using a 401(k) to your advantage.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. 

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed. 

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk, including loss of principal.

The information and content provided herein is general in nature and is for informational purposes only. It is not intended, and should not be construed, as a specific recommendation, individualized tax, legal, or investment advice. Tax laws are subject to change, either prospectively or retroactively. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager) to help answer questions about specific situations or needs prior to taking any action based upon this information.

Supporting documentation for any claims or statistical information is available upon request.

HerMoney

The Retirement Plan Entrepreneurs Need

F or women entrepreneurs, preparing for retirement should be a primary focus. Unfortunately, for many it is not. Women business owners are often so focused on growing their business that retirement planning falls by the wayside. If you own your own business, but haven’t started planning for the future, read on for details on the retirement plan entrepreneurs need.

Not Retiring = Not Realistic

According to BMO Wealth Management’s 2023 BMO for Women Report: The State of Financial Planning for Business Owners 1 , 2 5% of women entrepreneurs say they do not currently have a transition plan for their business and have never considered a transition plan. 2 One of the main reasons cited was that the business owners “did not plan” on retiring.

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It’s completely understandable. You’re working around the clock to grow your business and you probably took a huge risk in the first place to even launch it. How could you ever step aside and retire? However, not retiring is not realistic – we will all retire one day, after all. Even if you don’t want to retire, something outside of your control may force it upon you. That’s why planning for this inevitability can help make your retirement go smoothly for you, your employees and whomever may take over your business.

The Three Keys To The Retirement Plan Entrepreneurs Need

Once you’ve come to the realization that you will eventually retire, it’s time to start devising a plan, which can be easier said than done. Women need to do a better job of building a succession plan and incorporating that into a comprehensive financial plan. This takes time, which likely is why only 38% of the women surveyed said they have a plan to prepare the next generation or key persons to take over their business in the future, for example. The retirement plan entrepreneurs need starts with three key action items:

1. Start saving immediately.

There’s a lot of pressure to conserve resources for your business, even at the expense of your personal finances, but the key to saving for retirement is time. For every year that you save for retirement, you increase the power of compounding interest, which thrives over long periods of time. For example, if you start investing $200 per month at 25 years old – and we’re assuming a 6% rate of return – by the time you turn 65, you will have a nest egg worth $393,700. But if you wait until 35 or older to start saving $200 a month, even with the same rate of return, you will end up with almost half that — $201,100 — by age 65 4 .

Even if only $100 per month, start saving for retirement now. And, if you can, max out your 401(k) plan each year.

2. Don’t ignore insurance.

Do you have personal life insurance in case a partner or additional breadwinner dies? Do you have disability insurance to cover your personal expenses if you can no longer work? A major component of retirement planning is about preparing for the unexpected — even before retirement begins. A tragedy that occurs during your working years could affect your business and personal finances, which can hinder your ability to save for retirement.

Key person insurance (often called COLI, company-owned life insurance) is a life insurance policy purchased by the business on behalf of the business owner or top executive. The business both pays the policy premium and is the beneficiary of the policy. Key person insurance guarantees that even in the event of the death of the owner, the business can continue with the right funds.

Insurance can take on even greater importance when you’re an entrepreneur.

3. Formulate a succession plan. 

Only 68% of women have considered how to prepare the next generation or key persons to take over their business someday, according to our survey 5 . Succession planning can have significant business and personal finance implications.

On the financial side, it’s simply a matter of making sure you have enough money to support you and your family if you ever step away from your business — either voluntarily or involuntarily. You may never want to step aside from your business, but an unexpected health emergency may leave you with no other option. That’s why planning for this possibility through savings, investments or various insurance policies is critical, even during the early days of your business when you’re barely off the ground.

Consider transition planning as a necessary tool to mitigate situations beyond your control and to assist in the success of your business. This will not only help you protect your loved ones but also your employees and company stakeholders in the process.

The future is now

If you can start and run a successful business, you can establish a transition plan. Think of it as a continuation of your dedication to your business and your staff. Don’t be afraid to ask for support from financial professionals who can help guide you toward a fruitful retirement.

More On HerMoney:

  • How To Hit The Retirement Savings Benchmarks If You Can’t Start Early
  • What I Hope My Daughter Learns From Me As Her Entrepreneur Mom
  • Five Retirement Myths Busted

SUBSCRIBE: Looking for more financial insights delivered right to your inbox?  We got you.  Let’s make this thing official with a free HerMoney subscription today !

The post The Retirement Plan Entrepreneurs Need appeared first on HerMoney .

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Tax Time Guide 2024: What to know before completing a tax return

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IR-2024-45, Feb. 21, 2024

WASHINGTON — During the busiest time of the tax filing season, the Internal Revenue Service kicked off its 2024 Tax Time Guide series to help remind taxpayers of key items they’ll need to file a 2023 tax return.

As part of its four-part, weekly Tax Time Guide series, the IRS continues to provide new and updated resources to help taxpayers file an accurate tax return. Taxpayers can count on IRS.gov for updated resources and tools along with a special free help page available around the clock. Taxpayers are also encouraged to read Publication 17, Your Federal Income Tax (For Individuals) for additional guidance.

Essentials to filing an accurate tax return

The deadline this tax season for filing Form 1040, U.S. Individual Income Tax Return , or 1040-SR, U.S. Tax Return for Seniors , is April 15, 2024. However, those who live in Maine or Massachusetts will have until April 17, 2024, to file due to official holidays observed in those states.

Taxpayers are advised to wait until they receive all their proper tax documents before filing their tax returns. Filing without all the necessary documents could lead to mistakes and potential delays.

It’s important for taxpayers to carefully review their documents for any inaccuracies or missing information. If any issues are found, taxpayers should contact the payer immediately to request a correction or confirm that the payer has their current mailing or email address on file.

Creating an IRS Online Account can provide taxpayers with secure access to information about their federal tax account, including payment history, tax records and other important information.

Having organized tax records can make the process of preparing a complete and accurate tax return easier and may also help taxpayers identify any overlooked deductions or credits .

Taxpayers who have an Individual Taxpayer Identification Number or ITIN may need to renew it if it has expired and is required for a U.S. federal tax return. If an expiring or expired ITIN is not renewed, the IRS can still accept the tax return, but it may result in processing delays or delays in credits owed.

Changes to credits and deductions for tax year 2023

Standard deduction amount increased. For 2023, the standard deduction amount has been increased for all filers. The amounts are:

  • Single or married filing separately — $13,850.
  • Head of household — $20,800.
  • Married filing jointly or qualifying surviving spouse — $27,700.

Additional child tax credit amount increased. The maximum additional child tax credit amount has increased to $1,600 for each qualifying child.

Child tax credit enhancements. Many changes to the Child tax credit (CTC) that had been implemented by the American Rescue Plan Act of 2021 have expired.

However, the IRS continues to closely monitor legislation being considered by Congress affecting the Child Tax Credit. The IRS reminds taxpayers eligible for the Child Tax Credit that they should not wait to file their 2023 tax return this filing season. If Congress changes the CTC guidelines, the IRS will automatically make adjustments for those who have already filed so no additional action will be needed by those eligible taxpayers.

Under current law, for tax year 2023, the following currently apply:

  • The enhanced credit allowed for qualifying children under age 6 and children under age 18 has expired. For 2023, the initial amount of the CTC is $2,000 for each qualifying child. The credit amount begins to phase out where AGI income exceeds $200,000 ($400,000 in the case of a joint return). The amount of the CTC that can be claimed as a refundable credit is limited as it was in 2020 except that the maximum ACTC amount for each qualifying child increased to $1,500.
  • The increased age allowance for a qualifying child has expired. A child must be under age 17 at the end of 2023 to be a qualifying child.

Changes to the Earned Income Tax Credit (EITC). The enhancements for taxpayers without a qualifying child implemented by the American Rescue Plan Act of 2021 will not apply for tax year 2023. To claim the EITC without a qualifying child in 2023, taxpayers must be at least age 25 but under age 65 at the end of 2023. If a taxpayer is married filing a joint return, one spouse must be at least age 25 but under age 65 at the end of 2023.

Taxpayers may find more information on Child tax credits in the Instructions for Schedule 8812 (Form 1040) .

New Clean Vehicle Credit. The credit for new qualified plug-in electric drive motor vehicles has changed. This credit is now known as the Clean Vehicle Credit. The maximum amount of the credit and some of the requirements to claim the credit have changed. The credit is reported on Form 8936, Qualified Plug-In Electric Drive Motor Vehicle Credit , and on Form 1040, Schedule 3.

More information on these and other credit and deduction changes for tax year 2023 may be found in the Publication 17, Your Federal Income Tax (For Individuals) , taxpayer guide.

1099-K reporting requirements have not changed for tax year 2023

Following feedback from taxpayers, tax professionals and payment processors, and to reduce taxpayer confusion, the IRS recently released Notice 2023-74 announcing a delay of the new $600 reporting threshold for tax year 2023 on Form 1099-K, Payment Card and Third-Party Network Transactions . The previous reporting thresholds will remain in place for 2023.

The IRS has published a fact sheet with further information to assist taxpayers concerning changes to 1099-K reporting requirements for tax year 2023.

Form 1099-K reporting requirements

Taxpayers who take direct payment by credit, debit or gift cards for selling goods or providing services by customers or clients should get a Form 1099-K from their payment processor or payment settlement entity no matter how many payments they got or how much they were for.

If they used a payment app or online marketplace and received over $20,000 from over 200 transactions,

the payment app or online marketplace is required to send a Form 1099-K. However, they can send a Form 1099-K with lower amounts. Whether or not the taxpayer receives a Form 1099-K, they must still report any income on their tax return.

What’s taxable? It’s the profit from these activities that’s taxable income. The Form 1099-K shows the gross or total amount of payments received. Taxpayers can use it and other records to figure out the actual taxes they owe on any profits. Remember that all income, no matter the amount, is taxable unless the tax law says it isn’t – even if taxpayers don’t get a Form 1099-K.

What’s not taxable? Taxpayers shouldn’t receive a Form 1099-K for personal payments, including money received as a gift and for repayment of shared expenses. That money isn’t taxable. To prevent getting an inaccurate Form 1099-K, note those payments as “personal,” if possible.

Good recordkeeping is key. Be sure to keep good records because it helps when it’s time to file a tax return. It’s a good idea to keep business and personal transactions separate to make it easier to figure out what a taxpayer owes.

For details on what to do if a taxpayer gets a Form 1099-K in error or the information on their form is incorrect, visit IRS.gov/1099k  or find frequently asked questions at Form 1099-K FAQs .

Direct File pilot program provides a new option this year for some

The IRS launched the Direct File pilot program during the 2024 tax season. The pilot will give eligible taxpayers an option to prepare and electronically file their 2023 tax returns, for free, directly with the IRS.

The Direct File pilot program will be offered to eligible taxpayers in 12 pilot states who have relatively simple tax returns reporting only certain types of income and claiming limited credits and deductions. The 12 states currently participating in the Direct File pilot program are Arizona, California, Florida, Massachusetts, Nevada, New Hampshire, New York, South Dakota, Tennessee, Texas, Washington state and Wyoming. Taxpayers can check their eligibility at directfile.irs.gov .

The Direct File pilot is currently in the internal testing phase and will be more widely available in mid-March. Taxpayers can get the latest news about the pilot at Direct File pilot news and sign up to be notified when Direct File is open to new users.

Finally, for comprehensive information on all these and other changes for tax year 2023, taxpayers and tax professionals are encouraged to read the Publication 17, Your Federal Income Tax (For Individuals) , taxpayer guide, as well as visit other topics of taxpayer interest on IRS.gov.

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Up or down - how does the Official Cash Rate actually affect your mortgage rate?

Liam Dann

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Reminder, this is a Premium article and requires a subscription to read.

On Wednesday, all eyes will turn to the Reserve Bank as it decides where to set the Official Cash Rate (OCR).

If it goes up, then so too will mortgage rates (or your savings deposit rate). If it goes down, then your mortgage rate or deposit rates should also follow.

At least that’s how it should work in theory. Unfortunately, things are seldom quite that simple.

So first...

What is the OCR and how does it move your mortgage rate?

As a working definition, we can think of the OCR as the wholesale price for lending and borrowing money.

It’s the baseline interest rate, the starting point for banks before they add their margins.

How the Reserve Bank (RBNZ) controls that rate is where it gets more technical.

The big retail banks hold accounts with the RBNZ and these accounts are used to settle transactions at the end of the day.

When you buy something electronically, there’s usually a transaction between two banks that needs to be settled.

The accounts with the RBNZ are used to cover transactions that haven’t yet been matched up at the end of the day.

By fulfilling that function, the RBNZ can both charge and pay interest. And by doing that, at the lowest available domestic rate, it effectively sets the floor for all other domestic interest rates.

How effective is it really though?

There’s clearly a strong correlation between the OCR and bank rates - as anyone who has refixed in the past six months will have felt.

It certainly does the job of setting the general price conditions for the cost of borrowing.

But the extent to which it works and the speed at which it works are difficult questions to answer precisely.

The RBNZ has done - and continues to do - extensive research work assessing how the effects flow through (what they call transmission) from the OCR to bank rates.

RBNZ research in 2021 found that a 1 per cent change in the OCR typically moves average two-year mortgage rates by 0.34 per cent within one month.

The pass-through from changes in monetary policy increases over time, with the peak impact on mortgage rates about six months after the change in the OCR.

At that point, about 80 per cent of the initial 1 per cent change in the OCR is typically passed through in higher or lower mortgage rates.

One factor limiting the direct impact of the OCR is to do with the amount of funding banks get from offshore markets, as opposed to local deposit-taking.

The more international funding they use, the less they need to rely on the local rate. But high levels of international funding also make banks (and Kiwis) more vulnerable to global financial shocks. After the Global Financial Crisis in 2008, the proportion of funding banks could source from offshore was limited.

The time it takes the OCR to shift rates is affected by the way we borrow from the banks, ie how many people float their mortgage, how many fix their mortgage... and how long they fix for.

If, like a lot of Kiwis, you fix your mortgage for a year or two, then you won’t feel the OCR change until you refix.

When you do refix, longer-term rates will price in what the bank thinks interest rates will do across that period. Shorter-term rates are more likely to be closer to the OCR.

In Australia, a lot more of the borrowing public keep their mortgages floating - so the official cash rates transmit much quicker.

In the US, it is a wonder it transmits at all - it is common there to fix a mortgage for 30-year terms.

How much short-term funding banks use and how much long-term funding they use can also affect the rates they offer relative to the OCR.

What about bank competition (or lack of it?)

The margins banks charge above the OCR are always contentious. If there is a lot of competition, then they may be forced to reduce the margin and the bank rates should be closer to the OCR rate.

If competition is lacking, then they’ll have space to charge more.

Despite concerns about a lack of competition, there is clearly some price tension in the market. We see that when banks move rates on or shortly after an OCR decision. The real costs haven’t passed through at that point but banks often use the extra public attention on rates to maximise the marketing power of a timely move.

Okay, that’s the OCR... but why do we sometimes talk about the MPS?

The Reserve Bank makes an OCR call roughly every six weeks at a Monetary Policy Review (MPS). But just to confuse things, every three months the review is part of a broader MPS.

So there’s always an OCR decision at an MPS but there isn’t an MPS with every OCR decision.

The MPS includes a lengthy written analysis of the economy and how it is looking to the RBNZ and a fresh set of economic forecasts.

This Wednesday, we’ll get the February MPS as well as the latest OCR decision.

That makes it especially exciting to economists and business journalists. To join the excitement, tune in at 2pm on Wednesday for full coverage.

Liam Dann is Business Editor-at-Large for the New Zealand Herald . He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003.

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  29. Up or down

    Adrian Orr has the power to affect the OCR and hence mortgage and other bank rates. On Wednesday, all eyes will turn to the Reserve Bank as it decides where to set the Official Cash Rate (OCR).