It seems 401(k) retirement plans are ubiquitous in the American workplace, but in fact, only two-thirds of U.S. workers have access to them. However, this is changing rapidly. This change is driven by two important factors: the nationwide labor shortage that has pushed employers to improve their benefit offerings, and a relatively new federal law – the SECURE Act of 2019 – that rewards smaller businesses for offering retirement plans to their workers.

As a result, business owners who have delayed offering 401(k) plans are now jumping into the pool, and most of them are including optional plan features designed to encourage participation by all employees.

Common Resistance: Cost

The most common resistance to starting a 401(k) plan among small business owners is cost. The fees and setup costs associated with plans can seem daunting. However, they are deductible as a business expense and in most cases the total annual fees equal about half of one month’s salary for a key employee.

With the growing difficulty of recruiting and retaining good employees, most small business owners are seeing the value of making that investment. They want to give good employees a reason to stay with the company, and these instincts are correct. A 2021 survey from Betterment for Business, Betterment’s 401(k) business, found if 1,000 full-time employees found that 65% said they would leave their current jobs for one that offered a higher quality 401(k) or other retirement plan.

Today’s younger workers are participating in 401(k) plans at a higher rate than their parents did early in their careers, largely because 401(k) plans were a new phenomenon that many people didn’t understand. Today’s young workers have seen their parents benefit from 401(k) plans and are heeding parents’ advice to save more than they did.

An important factor in the costs for 401(k) plans is a tax credit – provided by the SECURE Act – that is applied against startup costs for a plan.

Retirement Plan Startup Tax Credit

Eligible employers may be able to claim the tax credits – up to $5,000 a year for three years – for the costs of starting a qualified plan like a 401(k) or a Self-Employment Plan (SEP) or SIMPLE IRA.

You qualify to claim this credit if:

  • You had 100 or fewer employees who received at least $5,000 in compensation from you for the preceding year
  • You had at least one plan participant who was a non-highly compensated employee (NHCE)
  • In the three tax years before the first year you’re eligible for the credit, your employees weren’t substantially the same employees who participated in another plan sponsored by you, a member of a controlled group that includes you, or a predecessor of either
  • If you add an automatic feature such as auto enrollment, this applies to not only new 401k plans, but existing plans can receive this tax credit as well once you add this feature.

Amount of the Credit

The credit is 50% of your eligible startup costs, up to the greater of:

  • $500; or
  • The lesser of:
    $250 multiplied by the number of NHCEs who are eligible to participate in the plan, or

Eligible Startup Costs

You may claim the credit for ordinary and necessary costs to:

  • Set up and administer the plan, and
  • Educate your employees about the plan.

Popular Plan Features

The companies jumping into 401(k) plans now tend to be smaller, with 10 to 20 employees, and willing to include features that help drive participation and contribution rates. These features include:

  • Automatic enrollment: employees who join the company are automatically enrolled in the plan at a standardized low salary deferral rate unless they opt out. They may elect later to defer salary at a higher rate.
  • One-on-one financial education: The company’s 401(k) plan advisor meets individually with plan participants to explain how the plan works and advise them, based on their age and life stage, how much salary they should defer and what types of investments would be beneficial. Some employers are making these education sessions mandatory for participants. For example, one client company saw their average salary deferral rate rise from 5% to 8%, and their overall participation rate rise from just below 50% to a jaw-dropping 98% as a result of the education sessions.
  • Employer match: Many employers match employee contributions up to a certain level – usually between 3% and 6% of total deferrals – for employees who contribute a certain base level of salary to the plan. Employer match funds can help fuel rapid growth in 401(k) accounts, and employees appreciate the idea of building their retirement nest eggs with “free money” from their employers.
  • Roth 401(k) options: A Roth option enables participants to save in two different ways. With a traditional 401(k), you defer before-tax money into your account, and when you retire and start withdrawing it, you pay taxes on distributions. Most retirees are in a lower tax bracket than they were during their working years, so the tax savings can be significant. With a Roth 401(k), you contribute after-tax money to the account, meaning you pay taxes on that portion of your salary now, but when you retire the withdrawals will be tax-free. Roth 401(k) plans exist alongside traditional 401(k) plans and are becoming very popular among plan participants.
  • Qualified default investment alternative: This feature is a best practice that directs salary deferrals to investment funds that are most appropriate to the participant’s age if they haven’t picked a fund option themselves.

Typical Startup Process

Some employers worry that starting up a 401(k) will be a lot of work for them and their staff, but if you hire the right providers to walk you through it, the startup activity should be manageable.

Typically, you’ll work with a plan advisor, a third-party administrator (TPA) and an investment fund company. The plan advisor will serve as a “General Manager” helping you understand how to keep your plan in compliance with state and federal laws and providing general guidance. The plan advisor also will coordinate the financial education part of your package.

Once you have made the decision to implement a 401(k) plan, it can be up and running in about 60 days. With the assistance of a plan advisor, you will need to:

  • Build a plan document with the assistance of your plan advisor that will define the rules and features of your plan.
  • Meet virtually with a record keeper who will need an accurate census of your workforce and will show you how to manage the payroll deferrals.
  • Schedule enrollment and educational sessions for your employees.

Strong Workplace Culture

Today’s employers are acutely aware of the role benefits play in recruiting and retaining good employees, and a strong retirement plan is your second most important benefit after your healthcare plan. A good retirement plan helps you build a strong workplace culture with the message that you care about your employees’ personal well-being.

If you would like to have a conversation about how you can implement a strong retirement plan for your employees, contact your Adams Brown wealth consultant.