Considering a Company 401k Plan?


401k Plans are a great way to prepare for retirement and retain employees

Qualified company retirement plans are plans that are tax deferred for the investors. Qualified plans are plans that both employees and employers contribute too and receive a tax deduction for their contributions.  The most common example of a qualified plan is a company 401(k).  Additionally, a defined benefit plan is an option for those looking to make higher contribution amounts than the 401k plan allows. Now-a-days defined benefit plans are becoming less and less popular but can still be a good savings instrument for high-net-worth business owners.  When considering a company 401(k) plan, employers need to understand that when they make company contributions these contributions need to be made for all eligible employees.  Company 401(k) plans are prohibited from discriminating in favor of officers, owners, shareholders, and highly compensated employees.  If a business owner is looking for a way to favor key employees then they may want to consider a nonqualified retirement plan.

Here are some metrics to look at when considering whether to offer a 401(k) plan with a company contribution.

– Has the company reached a level of stability?

– What is the future growth forecast?

– What is the cash flow history?

– Is the company losing talented employees for competitors with a better benefit offering?

Benefits of a qualified company retirement plan.

For a business owner a qualified retirement plan can be an excellent vehicle for deferring taxes and increasing future retirement income. The owner can get a deduction from the payroll contributions they make and then also get a business deduction on the company contributions.  This can also be a way to retain top talent and reduce taxes in the process by offering a company match or profit-sharing contribution.  The theory behind making pretax contributions while working is that these will be your high tax years. Later in retirement many will be in a lower tax bracket while they start taking withdrawals.  Older employees become more and more aware of the benefits of a 401(k) plan and can value the ability to use this savings vehicle to build a nest egg to live off during and through retirement.  Young employees stand to benefit most from 401(k) savings due to the long-time horizon their accounts can grow tax deferred.  From a business owner perspective, the cost of the plan can be shared amongst the employees. The plan also allows flexibility for the business owner to choose what the company match will be and what/if any profit sharing to make each year.

Potential disadvantages of establishing a 401k plan

Qualified plans have tax favored treatment with the Internal Revenue Service. With those tax favored treatments comes restrictions and administrative burdens that are imposed by the IRS.  The following are some regulatory factors that need to be considered by the plan administrator. These factors are closely regulated by plan auditors.

  • Contributions to employees
  • Federal reporting and disclosure requirements
  • Administrative expenses
  • Nondiscriminatory testing

These are all factors that plan administrators must have a defined process. For a qualified plan to keep its qualified, tax-favored status it must not discriminate its benefits towards highly compensated employees. There are certain testing requirements that must be met each year to ensure those qualifications are being met. Additionally regulatory factors around reporting and disclosure requirements must be provided to the IRA, ERISA and plan participants. This is the reason why many companies hire an outside fiduciary advisor to help them with this plan requirements.

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