401(k) plans have become the retirement plan of choice for many businesses. While they offer many advantages for the company and the employees, there are several issues that you should consider when evaluating them.
Why Have a 401(k) or Any Other Type of Retirement Plan?
- Offering a retirement plan as part of an employee benefit program helps three parties: the business, the owner and the employees.
- The right type of retirement plan can become an integral part of the management of your business. It can help attract, retain and motivate your employees. In an environment where keeping good employees is becoming more difficult, a good retirement plan and effective communication about the plan can be powerful tools.
- The right plan, properly structured, can also help the owner of the business build a substantial retirement nest egg.
- Finally, employees are keenly aware of the need to take control of their future financial security. Providing assistance with a company-sponsored retirement plan will help them reach their retirement goals.
What Is a 401(k) Plan?
A 401(k) plan is a company-sponsored profit-sharing plan that allows employees to defer a portion of their wages into investment options of their choice. Employers have the flexibility to make contributions and can offer some form of matching contributions to employees.
Why Consider a 401(k) Plan?
If your business has more than just a few employees, you'll want to provide an attractive employee benefit while retaining control over some aspects of the retirement plan. In this case a 401(k) plan may be your most attractive alternative. This form of retirement plan also allows for larger contributions than many other types of plans.
Key Aspects of a 401(k) Plan
- Any employer with one or more employees can establish a 401(k) plan. Usually, this type of plan can be economically feasible when a company has at least 25 employees.
- These plans allow for employees to contribute pre-tax dollars for their own benefit. It brings employees into the process of planning for their own retirements.
- The contribution limits are larger than those found with most other types of plans. Employees can defer up to $16,500 (in 2010) into their account. The total contribution, including employee and employer contributions, is limited to 25% of compensation up to $49,000 (for 2010).
- The 2001 tax law also created a "catch-up contribution" provision for participants aged 50 and older. Under this provision, in 2010, an eligible participant can contribute an additional $5,500 to his or her plan.
- The employer can attach a vesting schedule to any company contributions. This provides a strong motivation for employees to remain with your company. Employee contributions are immediately vested.
- The company can have control over some level of their contributions. Usually, the plan document provides a certain level of contribution matching of employee deferrals, but can allow the company to make a discretionary contribution, usually based on financial results.
- The 401(k) plan must be made available to all employees who are at least 21 years of age and who worked at least 1,000 hours in the previous year.
- Most 401(k) plans provide a great deal of investment flexibility. Participants choose where to invest their money among many alternatives. Usually, there are a number of mutual funds and often an option of company stock (if the company is publicly held).
- There are annual filings that must be made with the IRS and special testing to ensure that the plan does not discriminate in favor of highly compensated employees.
Investigating 401(k) Plans Further
The key parties needed for establishing and administering a 401(k) plan are an administrator and an investment manager. Many investment managers, including banks, mutual fund companies and some investment advisors, offer special bundled programs that include administrative services as well as their investment management options. There are IRS and Department of Labor filing requirements with 401(k) plans that can be part of their services as well.