A company's decision to establish a 401(k) plan usually results from two important considerations: Is it a sound business decision for the company, and is it a worthwhile benefit for employees? The relative weight of these factors depends on the company and the individuals involved. In the past, retirement plans were often seen as an expense that returned little benefit to a business. Today, the implementation of a 401(k) or a similar plan is commonly regarded as a strategic necessity and an integral part of a company's business plan.
Building a strong benefits package and making a company attractive to current or prospective employees is often the most compelling reason to establish a retirement plan. Also, the tax laws provide a credit for certain small businesses to help offset the costs associated with the setup and administration of a plan. An employer may also be eligible to receive a tax credit of up to $500 per year for each of the first three years of the plan.
A 401(k) plan can be very affordable. The expense of administering a plan and any discretionary contributions made by the employer are tax deductible for the company. More important, what are the costs of not offering a retirement plan? Companies that do not sponsor qualified plans may be at a disadvantage when recruiting and retaining employees. Imagine, for example, trying to attract a potential key employee who has built a substantial retirement account at another firm. When considering a new employer, a prospect will want to transfer their investment and the ability to continue to add to it.
Yes. There are, however, several advantages to making matching contributions. Offering a match can encourage employee participation, increase plan contribution amounts, and thus allow highly compensated participants to contribute higher percentages of their salaries.
One way is the "discretionary contribution" plan, where the employer decides how much or how little to contribute each year based on the profitability of the company. This is commonly known as a profit-sharing plan but a company is not required to have a profit in order to make a contribution. Properly administered, this method provides incentives and rewards, can help build company loyalty, and allows growing companies to increase or decrease contributions based on their ability to pay.
Health and retirement plans provide strong components in most benefit packages, offering an incentive for employees to remain with their employer. Matching contributions, additional discretionary contributions, as well as a vesting provision, further encourage long-term service.
Vesting involves entitlement. Elective contributions belong to participants from the time they are put in the plan. These funds are "100% vested" (the participant is entitled to all the money upon distribution). Stricter rules may be applied to employer contributions. Depending on the vesting schedule selected by the company, the employee may be vested in their employer contributions immediately or over a number of years. The vesting schedule is detailed in the plan's adoption agreement.
In general, all non-government employers can have a 401(k) plan. However, a company must meet strict qualification rules concerning administration of the plan. These include:
- The plan must be put in place for the benefit of all employees and their beneficiaries.
- The plan must be in writing and communicated to all eligible employees.
- Participation and contribution levels cannot discriminate in favor of highly compensated employees.
- The plan must be established with the intention of its being permanent.
No. Officers and highly compensated participants are allowed to make elective contributions to the plan, but the amount of that contribution depends on the average contributions of other participants. However, a 401(k) safe harbor provision allows highly compensated employees to make the maximum amount of elective contributions if the employer makes certain minimum contributions to non-highly compensated participants. Also, profit-sharing features like new comparability and age-weighted formulas allow the employer to maximize contributions to certain key earners, as defined by the employer.
A plan's design specifies how forfeitures are handled. Sometimes they are allocated among the remaining participants as additional non-elective contributions – a kind of a "bonus" contribution. They may also be used to reduce future plan administrative costs.
Employee assets (including those of company officers who are plan participants) cannot be accessed by the employing company or the company's creditors, no matter what the financial crisis, including bankruptcy. Individual participant accounts are also immune from the creditors of individual employees. Similar protection may not extend to IRAs. (State laws determine whether they are protected.)
Unlike Simplified Employee Pensions (SEPs), which require that part-time employees be covered, 401(k) plans may include or exclude employees accumulating less than 1,000 hours per year. This option, known as service requirements, is selected during plan design.
