Whether you’re running a giant corporation, a midsize company, or a one-person show, you can create a 401(k) plan. This article covers the different types of plans and the basics of what you need to know to start one.
- Any size business can start a 401(k) plan for its workers.
- There are several different types of 401(k) plans: traditional, SIMPLE, safe harbor, and one-participant.
- The right type for your business will depend largely on how many employees you have.
- The different types of plans can vary in terms of employee contribution limits and employer contribution requirements.
Types of 401(k) Plans
There are several types of 401(k) plans that employers can choose from. Which one is right for you will depend largely on how many employees you have.
You’re likely to find this type of plan at most large employers, although any size business can create one. Employees contribute to the plan through voluntary payroll deductions. Employers often match some percentage of their employees’ contributions, although there is no legal requirement that they do so. Some employers also offer a designated Roth 401(k) option as part of their plans, and employees can split their contributions between the two types if they wish.
SIMPLE is derived from the capital letters found in “Savings Incentive Match PLan for Employees.” These plans are intended for businesses with 100 or fewer employees.
SIMPLE 401(k) plans have lower employee contribution limits than traditional 401(k) plans. In 2023, for example, the limit is $15,500 for anyone under age 50 and $19,000 for those 50 and older, compared to $22,500 and $30,000, respectively, for traditional plans.
You’re required as an employer to make either a matching contribution of 1% to 3% of each employee’s pay for those who contribute to the plan or a nonelective contribution of 2% for all eligible employees, regardless of whether they contribute.
Safe Harbor 401(k)
A safe harbor 401(k) allows employers to avoid the nondiscrimination tests that most 401(k) plans must pass to comply with the law. Nondiscrimination tests are intended to ensure that retirement plans don’t favor highly compensated employees. Like SIMPLE 401(k) plans, safe harbor 401(k)s are often used by small businesses because they are easier to administer.
Also like SIMPLE 401(k) plans, safe harbor 401(k)s require that employers make annual contributions. Those contributions can take one of three forms:
- Nonelective Contributions—In this case, an employer makes a nonelective contribution equal to 3% of compensation on behalf of each employee who is not highly compensated. Employees are not required to contribute.
- Basic Match—With this, employers match 100% of each non-highly compensated employee’s elective contributions and up to 3% of their compensation, plus 50% of their next 2% in compensation.
- Enhanced Match—Here, employers have the option to calculate their match on up to 6% of the employee’s compensation, rather than just 5%.
Finally, even if your only employee is you (or you and your spouse), you can start a 401(k) plan for your business. A one-participant 401(k) is also known by a variety of other monikers, including solo 401(k), uni-k, self-employed 401(k), and individual 401(k).
Because you are both an employer and employee in the business, you can contribute to the plan in both roles. As an employee, you’re subject to the same limits as with a traditional 401(k) plan.
As your own employer, you can also make additional, nonelective contributions. The maximum here depends on how your business is set up for tax purposes (sole proprietorship or S corporation, for example). In 2023, you can contribute a total of up to $66,000 to the plan, plus another $7,500 if you’re 50 or older.
If your spouse is paid for working in the business, they can contribute up to the same maximums. They are also eligible for the additional employer contribution.
A 401(k) plan might not be your only (or best) option. Other types of employer-sponsored retirement plans include 403(b) plans for schools and nonprofits, 457 plans for government workers, and profit-sharing plans in the private sector.
How to Create a 401(k) Plan
Once you’ve decided on the type of 401(k) plan that’s most appropriate for your business, starting one can be relatively simple—especially if you bring in an experienced plan administrator, such as a mutual fund company, to assist you.
The Internal Revenue Service (IRS) breaks it into four steps:
- Adopting a written plan
- Arranging a trust fund for the plan’s assets
- Developing a record-keeping system
- Providing plan information to participants
Here’s a brief look at each requirement.
A Written Plan
The written plan describes how your plan works, the benefits for which your employees will be eligible, and how and when they become entitled to them. You’re responsible for adhering to the rules established in the plan, although you can amend them in the future.
Bear in mind that even if you farm out much of the work for administering your plan to another organization, you are still considered a fiduciary. This means that you have to act in the best financial interests of your employees and can be held personally responsible if you don’t.
A Trust Fund
One of the safeguards with 401(k) plans is that the money is held in a separate trust. As the employer, you get to choose the trustee, who may be one or more employees if you have staffers with the relevant expertise, or an outside organization that you hire. The trustee is also a fiduciary, responsible for making decisions that are in the best interests of plan participants.
A Record-Keeping System
Running a 401(k) plan requires a lot of bookkeeping. You’ll need to keep track of employee and employer contributions, gains and losses in individual accounts, and any distributions or loans that participants take. In many cases, even large employers delegate these administrative tasks to professional plan administrators.
Your written plan will become the basis for a document known as the Summary Plan Description (SPD). You’re required to furnish employees with a copy of the SPD after they become eligible to participate and update it when you make any significant changes to the plan. While it’s not a formal requirement, the IRS notes that “in addition, you may want to provide [all of] your employees with information that emphasizes the advantages of joining your 401(k) plan.”
Once your plan is up and running, you’ll also need to supply other information to participants, such as a summary annual report (SAR) on the plan’s finances each year and individual account statements either quarterly or annually, depending on your type of plan.
In addition to providing plan participants with information, employers or their plan administrators must file a financial report with the government each year, using Form 5500, Form 5500-SF, or Form 5500-EZ. Which form you’ll use depends on the type of 401(k) plan you have.
What is 401(k) plan automatic enrollment?
Automatic enrollment is a feature that employers can add to their 401(k) plans. It allows the employer to defer a portion of employees’ pay and deposit the money into a 401(k) account for them. Employees can opt out if they wish to do so. Plans with this feature are sometimes referred to as automatic enrollment 401(k)s.
The SECURE 2.0 Act, signed by President Biden on Dec. 29, 2022, makes automatic enrollment (with an opt-out provision) mandatory for newly created 401(k) plans for plan years beginning after Dec. 31, 2024.
Can an employer have both a 401(k) and a traditional pension plan?
That depends on the type of 401(k). An employer can have both a traditional or safe harbor 401(k) plan and a traditional, defined-benefit pension plan. However, employers with SIMPLE (Savings Incentive Match Plan for Employees) 401(k) plans cannot offer other retirement plans.
Who regulates 401(k) plans?
The primary federal regulator of 401(k) plans is the Employee Benefits Security Administration, which is part of the U.S. Department of Labor. As part of its enforcement of the Employee Retirement Income Security Act (ERISA), it provides compliance assistance to employers and 401(k) plan administrators.
The Bottom Line
If you’re an employer who’s considering creating a 401(k) plan for your employees, your first step is to decide which type of plan to offer. After that, you’ll need to create a written plan describing how your 401(k) works and make sure that you comply with it going forward. Unless you are already familiar with all the rules governing 401(k) plans, you will probably want to bring in an experienced plan administrator to assist you.