With the growing expectation of tax hikes in the year ahead, more small businesses are turning to 401(k) plans to help increase personal and business savings.
While it’s no secret that 401(k) plans offer small business owners and their employees hefty contribution limits, access to cash and a powerful way to reward employees, they’ve still been a hard sell to small businesses that have viewed them as costly and complex. However, the landscape has changed quite a bit over the last decade, as pricing has come down to where they are now affordable to even the smallest businesses.
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The right 401(k) plan can be very simple to select and manage once you understand your options. The first thing to understand is the three types of 401(k) plans including:
The Safe Harbor 401(k)
The Safe Harbor 401(k) is very popular among businesses with less than 15 employees. These plans allow business owners to contribute the maximum deferral amount to their own account ($16,500 in 2010 or $22,000 for those 50 and over) and, at the same time, automatically satisfy IRS non-discrimination testing -- a governmental check and balance that ensures plans serve all employees and not just a few at the top.
By providing a small “safe harbor” match -- an amount the employer puts into an employee’s 401(k) account as a percent of an employee’s salary -- any employee, including the owner, can contribute the maximum to the plan and receive the match. This employer contribution is what helps the business avoid the hassles of government discrimination testing. It’s also what gives owners and highly-compensated employees the ability to maximize tax-deferred contributions without the restrictions which can frequently be an issue for those going with a traditional plan. Tax-deferred contributions can lower annual personal taxes for the employee, too.
If a business has steady revenues and its employees aren’t likely to contribute a lot to the plan, a Safe Harbor 401(k) may be the best way to go. The government deadline for starting a Safe Harbor 401(k) for 2010 is October 1, but most providers have internal deadlines a couple of weeks earlier to allow for the time needed to set them up.
The Traditional 401(k)
A traditional 401(k) plan enables small business owners to customize the way they reward their own employees. For example, these plans allow owners to determine if they’d like to simply give their employees a vehicle for saving money or to also provide a match from the company. If an owner decides to match, he can choose at what percentage of his employees’ salaries and, on a related note, whether to add a vesting schedule. With a Safe Harbor plan, a 3 to 4% match is typically required and the employer matching is vested immediately – meaning it is the employee’s money once it hits their account.
With a traditional 401(k), the business owner can also choose over what time period and at what percentage he contributes to the plan before it actually becomes the employees. For example, an owner could elect to match 3% of contributions made by eligible employees but it will vest over, say, a three year period. For example, the owner might also allow for 50% of the amount the company contributed to become the employees in year one, 25% in year two and the remaining 25% in year three. After three full years, 100% of matches are fully vested. This can be a nice feature for a company that tends to experience high turnover as unvested amounts are returned to the plan to use for future matching contributions.
These plans can also be a good fit for businesses that are highly seasonal, or for those whose employees are expected to contribute 7% or more of their salaries. In a traditional 401(k) plan, employers and highly-compensated employees (those making $110K or more in 2010) can contribute 2% more of their salary than the average percent of salary contributed by non-highly-compensated employees. So if the average employee in the business contributes 5%, the owner will be restricted to contribute no more than 7% of his salary.
An Advanced Profit Sharing 401(k)
The last type of 401(k) to consider is better-known as an advanced-profit-sharing plan. This type of plan rewards employees based on their performance and overall role in the company’s success.
Advanced-profit-sharing plans can be a nice fit for companies that have several levels of employees. For example, a legal firm has partners who bring-in and own the business, front-line attorneys who work on each case, as well as support staff that handle administrative aspects of the firm’s business. Each group is essential to the business, but also has unique goals that contribute to the firm’s success. Advanced profit sharing enables a meaningful way to reward employees in each group based on reaching goals and improving the business. This can be great for the employees and a way for the firm to better manage the cost of sharing profits. For these plans to really work, they will likely also need to provide a safe-harbor employer contribution.
If the tough business environment of the last few years has taught small businesses anything it’s the importance of having money set aside for the future. 401(k) plans in today’s marketplace are making it easier for small businesses to arm themselves and their employees with the tools they need to save on taxes now and build a nest egg for tomorrow.
Stuart Robertson is general manager and principal of ShareBuilder Advisors, LLC which operates www.ShareBuilder401k.com. ShareBuilder Advisors, LLC is a subsidiary of ING Bank, fsb.
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