Small Business 401k Small Business 401k Plans is an overview of how entrepreneurs can set up employee retirement plans and keep them compliant.

Providing a 401k plan to your employees helps you be more competitive as an employer, it has the potential to boost employee satisfaction, and it genuinely helps your employees save for their futures. Unfortunately, setting up a 401k plan when you’re a small employer can be daunting. However, if you know the right information about 401k rules and regulations, it may be easier than you think:

Getting Started with Small Business 401k Plans:

Setting up a 401k plan starts a few necessary steps:

  • Adopt or create a written plan document (Summary Plan Document)
  • Set up a trust
  • Adopt Safe Harbor Provisions for a 401-k plan
  • License a recordkeeping system
  • Share plan information with employees who want to participate

While you can work through these steps on your own, the process is more straightforward with assistance from a retirement plan professional or with help from a financial institution such as a bank, mutual fund provider or an insurance company.

To explain, the written plan details which type of 401k you have selected as well as information on the plan’s day-to-day operations. The trust holds the participant’s assets and must be governed by a trustee. Recordkeeping involves tracking contributions, earnings, and losses, as well as plan investments, expenses, and distributions. It also includes submitting the correct forms to the IRS at the end of each tax year. Finally, plan information deals with informing participants about the plan and how it works, by preparing some documents including a summary plan description.

Choosing a 401k Plan

As a small business owner, your three main plan choices include

  • Traditional 401k
  • Safe Harbor 401k
  • Roth 401k

Both traditional and safe harbor 401k’s accept pre-tax contributions, meaning your employees do not have to pay income tax on their contributions. Roth plans, in contrast, use post-tax funds, but withdrawals during retirement are not taxed. Although there can be advantages to Roth 401ks, most employees opt for traditional or safe harbor plans to provide direct tax and savings benefits to their employees.

With a traditional 401k plan, you have to prove to the IRS that the plan does not benefit owners and management over employees, and to do that, you must track the actual deferral percentage (ADP) and actual contribution percentage (ACP) of your plan. ADP compares plan contributions as a percentage of income between highly compensated employees and non-highly compensated employees, and the difference must not exceed two percentage points. The ACP covers similar issues. The rationale behind this rule is that if you decide to offer a benefit like a retirement plan, you are not supposed to use it to channel large bonuses to executives and managers. Instead, you should use it to help all of your employee’s contributions.

With safe harbor plans, in contrast, you don’t have to worry about these anti-discrimination clauses; instead, these plans are set up with regulations that quickly help you avoid discrimination issues. In particular, under a safe harbor plan, you are required to make contributions to your employee’s account.

As of 2018, you can match 100% of employee contributions up to 3% of income, and you can match contributions between 3 and 5% at 50%. For example, if your employee has a $1,000 paycheck, and he contributes 5%, he contributes $50. You may match the first 3% dollar for dollar, making your match $30, and then, you may match half of the remaining contribution, making your additional matching amount $10. As a result, your employee contributes $50, and you add $40. If your employee contributes more than 5% of their paycheck, you cannot match the amount that exceeds 5%.

Alternatively, under current 401k rules and regulations regarding safe harbor plans, you may make nonelective contributions equal to 3% of compensation, regardless of whether or not your employee decides to contribute. In contrast, with a traditional plan, you can match employee contributions, but you don’t have to. However, you have to ensure your ACP and ADP levels are compliant.

Controlled Group

In addition to ACP and ADP, ERISA (the Employee Retirement Income Security Act of 1974), also contains a set of rules that define a controlled group. Also designed to prevent discrimination in employer contributions, the controlled group rule considers two or more employers with common owners to be a single employer for 401k nondiscrimination testing.

These small business 401 k rules prevent employers from creating two companies and placing all of their highly compensated employees in one and all of their lowest paid employees in another to circumnavigate ADP and ACP expectations. If two or more employers have a brother-sister or parent-subsidiary relationship, they are considered to be a controlled group and must report all of their employees’ 401k information together as if the businesses are a single entity.

A parent-subsidiary relationship occurs when one company owns more than 80% of another company, and a brother-sister relationship happens when 5 or fewer individuals own 80% of all the companies involved or when the common owners have same ownership of more than 50% in each company.

Contribution Limits

In addition to understanding controlled groups and other anti-discrimination clauses of the small business 401 k rules, it’s also important to understand the basics of contribution limits. As of 2018, employees cannot contribute more than $18,500 to their 401k plans, but participants over the age of 50 may make additional catch up contributions up to $6,000 per year. The total of employee and employer contributions cannot exceed the greater of $53,000 or 100% of the employee’s annual compensation.

Fiduciary Responsibilities

As you make decisions about your business’s 401k plan — ranging from hiring someone to manage the plan to choosing which investments to make available — you are assuming a level of fiduciary responsibility, and as a result, you are required to observe specific guidelines such as the following:

  • Acting in the interest of the plan participants
  • Serving to provide benefits for participants and helping them to avoid unnecessary plan expenses
  • Completing fiduciary responsibilities with skill and diligence
  • Abiding by plan documents
  • Diversifying investments
  • Depositing contributions to the plan’s trust within seven business days of receiving them if you have less than 100 employees or by the 15th business day of the following month if you have more than 100 employees

Whether you handle the fiduciary responsibilities yourself or hire someone to control them, you or that individual must be covered by a fidelity bond. This ensures the plan against losses related to fraud or dishonesty from the fiduciary.

Reporting to the Government

One of the primary small business 401k rules is that businesses must submit an annual report to the IRS and the U.S. Department of Labor. Form 5500 satisfies this requirement, and in addition to the primary form, there is a short version and an accessible version for small businesses and one-participant plans, respectively.

If any of your participants have taken disbursements from their accounts, you also must fill out Form 1099-R and give one to the participant and submit another to the government. Additionally, Form 8955-SSA is the annual registration statement to identify separated participants with deferred vested benefits.

Small business 401k rules can be confusing, but to alleviate confusion and make ERISA compliance easier, the government has created safe harbor plans. However, even if you opt for a safe harbor plan, you have to ensure compliance. In most cases, the easiest way to do so is by eliciting the help of a plan representative or trustee.

However, the IRS and the U.S. Department of Labor understand that mistakes happen, and they have programs in place to allow you to correct errors. Ideally, you should review your plan regularly to ensure compliance, and you should reach out to the relevant agency if you realize you have made a mistake. Unfortunately, failure to report errors can result in suspension of your ability to administer a 401k plan.

Disclaimer: Small Business 401k Plans is an informational article and is not accounting, legal, or tax advice.  Government regulations regarding 401k plans evolve, and while we make an effort to keep up to date, we cannot guarantee the accuracy or timeliness. For your specific situation, please consult professional advisors – tax, legal, accounting, and benefits consultants – to evaluate what fits your small business.

Small Business 401k Plans: Additional Sources of Information