The 401(k) is a retirement plan implemented and provided to
employees by their employer as a means to save for their
retirement. Not only do many employers contribute to the
employees 401(k) along with employee contributions (this is
known as matching), but the contributions are pre-tax
contributions; in other words the deduction is taken prior to
calculating the state and federal taxes due on the wages. This
helps not only the employee, but also the employer.
There are several variations of the 401(k) and depending upon
your employer's status as a small business, and their ability to
fund a 401(k), you may operate under a SIMPLE 401(k), a
traditional 401(k), or The Safe Harbor 401(k). All the plans
vary as to their contribution limits, the employers required
matching contributions, and the level of administration and IRS
reporting that must be factored into the plan upkeep. Let's take
a look at each of the plans, and discuss some of the advantages
and disadvantages of each.
The SIMPLE 401(k) is best suited for small businesses that have
a reliable earnings stream. In other words, their cash flow and
earnings level are fairly steady and reliable, and they want to
establish an easily controlled method for providing for
retirement funding. Quite often, many of the family members will
participate in the 401(k) as a way to fund their own retirement,
and offset some of the taxable income from the family business.
The disadvantage in operating this type of retirement account
lies in the fact that contributions made on behalf of the
employee by the employer are not optional, and some form of
contribution must be made each year. The traditional 401(k) is
the most often avoided plan by small to medium sized businesses,
simply because of the massive reporting requirements, and the
compliance testing that must be done each year. The
administrative costs for the traditional 401(k) for a company of
about 10 employees costs around $2000 per year to administer,
and that doesn't include the setup costs or the costs of loan
features. In addition to the optional features costs, there is
the cost of offering many investment choices. Most of the 401(k)
plans for small businesses that were surveyed had a much better
rate of participation as well as lowered plan costs when only a
few options were offered, instead of 10 or more.
The compliance testing that must be done with the traditional
401(k) are quite complex, and require much involvement by the
accounting or payroll department of the business. Today, many
small businesses outsource their payroll function, and include
the 401(k) plan administration as one of the outsourced
functions also. The greatest advantage to the small business is
that the business is not required to contribute to the plan,
unless there is a significant imbalance in the contributions of
the highly compensated employees versus the lesser paid
employees.
The Safe Harbor 401(k) is a spin-off of the traditional plan,
except for the fact that there aren't all the compliance
requirements and testing that must be completed each year. The
Safe Harbor plan is best suited for the small business that has
a steady revenue stream, and that is able to make a required
contribution each year to the employee fund. The employer must
make a 3% contribution to all employees who qualify for
retirement funding, regardless of whether the employee makes a
contribution; also, the employer contribution level for
non-highly compensated employees must not differ more than 2%
from the highly compensated employee contribution rate. In this
manner, the employer is required to provide the same benefits
for all employees, without all the compliance testing of the
traditional plan. The Safe Harbor 401(k) is simple to set up,
and can be accomplished within 30 days of the new year, and is
simple to administer. The disadvantage to this plan is the
required contribution rates, and if the business does not have a
steady cash or revenue flow, it is not a recommended plan.
After examining the different plan options available for small
to medium companies, there should be at least one that fits
within any small businesses scope of operations. Providing
retirement funding for small business family members, as well as
all other employees is one of the greatest benefits a company
can offer current and prospective employees.
About the author:
Tony Robinson is a Webmaster and International Author. Visit
http://www.tax-portal.com/ for his tax tips.
