Small Business 401(k) Plan Options and Basic Rules

Last Updated: Mar , 207
Thnkng about startng a 40(k) retrement plan for your small busness employees and for yourself?There are several types of plans to choose from. Here’s an overvew of optons for busnesses wth employees and for person busnesses.

As a small busness owner, you may decde to start a 40(k) plan for any number of reasons ncludng the fact that a qualty 40(k) plan can be a powerful recrutng tool. Every busness wants to attract the best and the brghtest. Showng potental employees you have a concern about ther future retrement can be a bg plus.

A wellconstructed 40(k) plan can also provde ncentve for talented employees to stay. Once you’ve nvested the and expense requred to tran a qualty employee, keepng them on board s n your fnancal best nterest.

Fnally, there are the benefts you realze from takng a tax deducton for your contrbutons to employees’ accounts.

Whatever your reasons, establshng a 40(k) plan nvolves certan requred steps. Step one s choosng whch type of 40(k) plan to offer.

Choosng a Plan

The nternal Revenue Servce provdes gudance on the varous types of 40(k) plans avalable to small busnesses. Read IRS Publication 560 before makng the choce to open any one of these plans:

Tradtonal 40(k) Plan

A tradtonal 40(k) plan allows employees to use pretax money to contrbute. Ths means the employee pays no ncome taxes on the money before t goes n to the 40(k) account.

As the employer, dependng on the plan desgn, you have the opton to contrbute on behalf of partcpatng employees. Ths s generally referred to as the employer match.

Your contrbutons can be subject to vestng over so employees are encouraged to stay n the plan to avod forfeture of some part of your matchng contrbutons.

Your 40(k) plan s subject to annual tests to ensure t meets RS nondscrmnaton requrements ncludng dscrmnaton n favor of hghly compensated ndvduals.

Solo Partcpant 40(k) Plan

The Solo Partcpant plan s also known as the Onepartcpant or Unk plan. t s not a separate type of plan, but rather a tradtonal plan desgned for a busness owner wth no employees. (Or, a sole owner wth famly members.) The rules for ths plan are the same as those for a tradtonal 40(k) plan. The plan s dscussed at length here.

Harbor 40(k) Plan

A harbor 40(k) plan s much lke a tradtonal 40(k) plan. Your contrbutons as the employer, however, must be consdered fully vested when made. These plans are not subject to the same nondscrmnaton tests as the tradtonal 40(k) plans.

Learn more about the Harbor 40(k) here.

harbor and tradtonal plans are approprate for any sze busness. They can also be combned wth many of the other retrement plans.

SMPLE 40(k) Plan

A SMPLE 40(k) plan s attractve because, as wth a harbor 40(k) plan, the annual nondscrmnaton tests not apply. Also, as wth the harbor 40(k), your employer contrbutons must be consdered fully vested when you make them.

Ths plan s avalable to you f you have 00 or fewer employees and they each receved $5,000 or more n the prevous calendar year. Your employees n a SMPLE 40(k) plan are not allowed to partcpate n any other qualfed retrement plan.

To learn more about all three types of 40(k) plans, refer to Publication 4222, 40(k) Plans for Small Busnesses.

Roth 40 (k) Allowance

Under RS rules, 40(k) plans allow your employees to desgnate some or all of ther electve deferrals as “Roth electve deferrals.” These deferrals generally follow the same rules as Roth RAs. Page 8 of IRS Publication 560 dscusses the Roth allowance.

Addtonal Rules

Condtons of partcpaton – A 40(k) plan cannot requre that an employee be wth the company more than one year n order to be elgble to partcpate.

Automatc enrollment – A 40(k) plan can have an automatc enrollment feature. The employee, however, must be able to choose not to have hs or her wages reduced and select the percentage of ther pay to contrbute.

Electve deferral lmtsIRS code 402(g) lmts the amount that a partcpant can defer on a pretax bass each year.

Matchng contrbutonsf the 40(k) plan contract allows, you as employer can make matchng contrbutons for any employee who contrbutes to ther 40(k) plan account.

Other employer contrbutons – f the plan allows, you can make addtonal contrbutons on top of the employee match for partcpants, ncludng those who n’t want to contrbute electve deferrals to the 40(k) plan.

Employee compensaton lmt – $255,000 of an employee’s compensaton can be the bass for determnng contrbutons.

Vestng – By law, your employees are consdered fully vested n any electve deferrals they make. Your plan may provde for vestng over several years for matchng or other contrbutons you make.

Whch Should You Choose?

Each of these plans s desgned for a dfferent type of busness makng a specfc recommendaton mpossble. f you are unsure, a tax professonal, , or accountant can help. Also, ask other small for ther experences wth the plans.

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