Whether you have a plan already or are considering your options for how to structure a new program for your company, it’s important to understand what a 401(k) plan is able to do and where it might fall short of expectations. We have already developed a decent analysis of the pros and cons of all types of qualified retirement plans (some you may have never heard of!) and their myriad options, so once you’re done here you might consider jumping over to our Retirement Plan Comparisons page. Before going through your qualified plan options, though, it would be helpful if you already decided you want one, so here are some Q&A which might clear some stuff up:
- Can a 401(k) eliminate the need to pay taxes at the business level? No, but it can certainly help reduce them. Payroll taxes? Can’t help you there. Self-employment taxes? Sorry, no (but deferrals help). Corporate income tax? You bet! As a matter of fact, profits are not even a prerequisite for making profit sharing contributions…it’s just that your CPA may want to know what exactly you’re thinking. The maximum deductible contribution to a defined contribution plan (an example being a 401(k) but not a pension plan) is 25% of “eligible compensation”, so there is a limit to the deduction a business is able to take via plan contributions each year.
- Can company benefits to the 401(k) plan go to the staff who earned them? This question can be tricky:
- Can you give benefits to only employees you want? Maybe, but only if all benefiting employees are classified as not highly compensated (i.e., non-owners or owner relatives, earn less than $150k gross income in 2023).
- Can you give benefits to only employees who choose to participate? Yes! This is called a “match” contribution and makes a lot of sense to businesses sponsoring a retirement program. It has its limitations, though (get used to it!), as these benefits are tested for compliance using the Average Contribution Percentage (ACP) test. The exception to this are “safe harbor” match contributions which cannot provide greater than a 6% benefit or be subject to a vesting schedule.
- Do you have to offer the plan to all long-term employees? No! You may create class exclusions which prevent employees who meet the eligibility requirements for your plan from the opportunity to participate. However, the share of employees affected by such an approach cannot exceed 30% of the number of all employees who have met the eligibility criteria. As you might have already expected, rules apply to the definition of these classifications. These rules essentially state that the plan cannot use language to prevent an extension of the maximum eligibility restriction of age 21 and employment of 1 year during which 1,000 hours of service are performed, such as “Employees born after 1972” or “Employees whose normal work week is less than 30 hours”. Also, you may not create a class defined as a list of one or a number of specific/named employees. Some common and appropriate class exclusions include “seasonal workers”, “interns”, and “apprentices”.
In other words, if you had plans to start a program only for management or very select classifications of employee then perhaps a different program, like a non-qualified deferred compensation plan, is a better fit.
- How much of a share of the overall cost to fund the company contribution can the owners expect will be allocated to them? The best way to figure this out is to Contact BRI and request some free plan modeling! Generally, the more long-term employees there are, the smaller the share is going to find its way up top. Owner compensation as a share of overall payroll might also provide some insights. If employees are unlikely to participate, a match program may provide a decent share to owners but the benefit will be muted due to testing restrictions. Chances of a disproportionate owner benefit are greatest when both owner compensation and age is significantly higher than the average employee.
- How expensive is it to maintain a 401(k) plan? There are three services that need to be provided to all 401(k) plans (though some might come from the same provider) and the cost of each is more often than not relative on either the number of participants in the plan, the amount of assets in the plan, or both. Here’s who they are and how they typically get paid (any expenses borne by the plan sponsor are deductible to the business):
- TPA – (10 participants (ppt) $215-246/ppt., 50 ppts $67-126) Paid based on number of employees eligible for the plan and the services provided, the structure including a base and a participant fee. The TPA is often the most expensive component of servicing a 401(k) plan but their fee stays as consistent as the participant count so as the trust grows, the TPA fee as a percentage of the trust consistently shrinks. It is typical that TPAs are paid directly from the plan sponsor but administration fees may be paid from trust assets.
- Financial advisor – ($1,500-6,000 or 25-75 basis points (bps) = 0.0025-00.0075%) Paid as a flat fee or as a percentage of trust assets via the investment share class that is made available to plan participants. Advisors who are paid from trust assets are paid very little on startup plans, so they should be greatly appreciated for all the work they do to help get a plan up and running! It is common for advisors to be paid from trust assets but this approach is steadily changing.
- Trust custodian – ($1,250-5,000 or 25-125bps) Paid as a flat fee or as a percentage of trust assets irrespective of the share class. It is common for the trust custodian to be paid from trust assets.
Don’t forget! The SECURE 2.0 Act has made some enticing tax credits available for companies who decide to put together a new plan- up to $15,000 or more over three years! Yes, there are a lot of factors to consider when putting a plan together, but you have a friend in Benefit Resources! Our mission is to help Americans retire on their own terms, not to be the TPA to every retirement plan in the country. If you have questions, we’re here to help you answer them without any pressure to sign up for our services. If you like our approach and appreciate the value we add, we would be honored to help oversee your plan like it was our own. If you have a friend who might learn a thing or two after reading this article, please share it!
Do you have any questions I failed to include in this article? Did you put a plan together yourself only to realize very important factors later on? Let me know in the comments and help other business owners understand what’s important when it comes to putting a 401(k) plan together!