A 401(k) plan is one of the most common retirement savings vehicles offered by employers in the United States, in no small part because it helps employees save for their golden years.
And in this economy, any support is helpful: A 2023 Schwab survey of 401(k) participants found that, on average, workers believe they'll need $1.8 million saved for retirement.
As a result, these retirement plans are an excellent tool for early-stage startups eager to attract and retain high-performing employees at their organizations. If you're interested in setting up a 401(k) plan at your own company, here's what you need to know before you get started:
- Rules and requirements to know before setting up a 401(k) for your startup
- How to set up a 401(k) plan for your employees
- Frequently asked 401(k) questions for first-time employers
- 401(k) plan administration made simple with Warp
Rules and requirements to know before setting up a 401(k) for your startup
On its website, the Internal Revenue Service (IRS) lists several 401(k) plan qualification requirements and rules that all plan providers must follow. In this section, we'll go over some of the most important ones you should know about.
Employee participation standards
Employers offering 401(k) plans must allow employees to participate in these plans once they meet both of the following requirements:
- They reach 21 years of age
- They reach one year of service at the company (which the IRS defines as working 1,000 hours or more in a 12-month period)
However, employers can still allow employees to participate in their 401(k) plan before they reach these requirements. This means you can open up your retirement plan benefits to any new hires or employees under 21 if you want to do so.
Contribution limits
The IRS also establishes limits on the maximum amount employees and employers can contribute to a 401(k) plan in one year, based on annual cost-of-living adjustments.
In 2024, employees can contribute up to $23,000 in pre-tax money to their 401(k) plan. Employees age 50 and older, meanwhile, can contribute up to $30,500. Additionally, total contributions from an employee and employer in 2024 must not exceed $69,000 or 100% of the employee's salary (whichever is less).
Distribution rules
Finally, withdrawals from a 401(k) account (also known as distributions) are only allowed under certain circumstances, such as upon the employee's separation from the company, retirement, disability, or death.
Employees may also withdraw funds from their accounts once they reach 59.5 years of age or if they experience financial hardship. In the latter instance, employees must pay income taxes on any untaxed funds they receive and a 10% penalty fee for early withdrawal unless an exception applies.
How to set up a 401(k) plan for your employees
Because of the guidelines surrounding 401(k) plans, setting up one of these retirement plans for your organization isn't as simple as contacting a 401(k) provider and filling out a few forms.
You'll need to take several necessary steps to maintain compliance with federal mandates, which we cover below. Luckily, the company you work with can usually help you with some of them.
Review the small business guide to 401(k) plans published by the US Department of Labor for even more details on this setup process.
Choose what type of 401(k) plan to offer to employees
Before you choose a provider, it's important to educate yourself on the different types of 401(k) plans available today. This way, you can narrow your search for retirement plan providers based on the plan you want to establish for your startup.
Here are five 401(k) plans you should know about:
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Traditional 401(k) plan: This type of plan allows eligible employees to contribute to their account before taxes, which means they reduce their tax liability now in exchange for paying taxes on their withdrawals in the future. Employers must meet all compliance requirements to receive plan benefits.
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Roth 401(k) plan: Similar to Roth IRA plans, Roth 401(k) plans are funded with an employee's after-tax contributions so they can withdraw their retirement funds tax-free later in life. Employers must meet all compliance requirements with this type of plan as well.
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Safe harbor 401(k) plan: Employers must contribute to employee accounts with this type of plan, but in return, they don't have to conduct annual nondiscrimination testing to prove that they're treating all employees fairly under their plan.
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SIMPLE 401(k): This plan is available to businesses with 100 or fewer employees and offers lower contribution limits than its counterparts. Like the safe harbor plan, employers must contribute to employee accounts to waive the nondiscrimination testing mandate.
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Automatic enrollment 401(k) plan: This type of 401(k) allows companies to automatically enroll employees in the plan unless employees elect not to. All contributions are then placed in default investments unless, again, the employee chooses otherwise.
There is one more type of 401(k) plan, the solo 401(k) plan, which is only available to companies with no employees. Participation in these plans is limited to business owners and their spouses.
Choose a 401(k) provider
When choosing a 401(k) plan provider, some factors you should consider in your decision include:
- Pricing structure and additional fees
- Ease of setup
- Integration with your payroll software and other tech features
- Availability of compliance support and customer service
- Management of day-to-day administrative tasks
- The strength of their cybersecurity practices
A provider that makes it easy to set up and maintain this benefit program can help you comply with the many rules and regulations surrounding 401(k) plans. This, in turn, keeps costs low while ensuring every dollar you put toward your retirement plan brings a return for your startup.
Determine the details of your 401(k) plan and document it
Most 401(k) plans offer a wide range of customization options, from employer matching contributions to additional perks like automatic enrollment, so no two 401(k) plans will be identical.
Once you choose the type of plan you want to offer and your provider, you'll need to document the details of your 401(k) plan to comply with the requirements outlined in the IRS Code. Your 401(k) plan document should include information on topics like:
- Employee eligibility requirements
- Employer contributions to employee accounts
- Participant fees
- Benefits payment timelines
Once this document is submitted to and approved by the IRS, you and your provider will use it to guide your 401(k) benefits administration operations. Your employees may also refer to this document if they have questions about their plan benefits or account.
As you might imagine, this step can take time, especially if you're a new employer. To free up your time, many 401(k) plan providers take care of this task for you.
Open a trust account for your plan assets
After the IRS approves your plan document, you must open a trust to hold your retirement plan's assets. This ensures that the funds are used solely for your plan's participants and their beneficiaries.
At this time, you should also choose at least one trustee to manage the plan's contributions, investments, and distributions to participants. Make this decision carefully, as the person or entity you choose will determine the financial integrity of your 401(k) plan.
Set up a recordkeeping system
Next, you'll need to set up a recordkeeping system for your retirement plan, as this will allow you to accurately track employer and employee contributions, plan investments, earnings, losses, expenses, and benefit distributions. This system will also help you and your plan provider prepare the report you must file annually with the federal government (Form 5500).
If you lack the knowledge or bandwidth to handle this task yourself, consider hiring a recordkeeper to manage it for you.
Provide information to employees
Inform eligible employees about your new benefit offering, and give them the information they need to decide whether or not to participate in the retirement plan. In particular, employers must provide employees with a summary plan description (SPD), a document that describes the details of their 401(k) plan in clear and easy-to-understand terms.
Consider setting up an informal information session for your workforce so they can learn the details of the plan and raise any questions or issues they might have. Then, provide prospective participants with a point of contact to address any other concerns about the 401(k) plan.
Update participants on changes to the plan
As the plan sponsor, you're also responsible for communicating any plan changes to participants on a regular basis.
Retirement plans with participant-directed accounts, for instance, require benefits statements to be delivered to employees quarterly. Meanwhile, material changes to the plan must be disclosed to participants within 210 days of the end of the year in which the change was made.
Provide participating employees with timely updates on their investments, financial gains, account fees, and a disclosure form to help ensure your communications comply with IRS regulations. Include a copy of the SPD with every update so participants can review it if they have questions about their account or plan benefits.
Frequently asked 401(k) questions for first-time employers
Are employers required to match employee 401(k) retirement account contributions?
A 401(k) employer match refers to a company's contribution to an employee's 401(k) plan in addition to the employee's contribution.
The amount an employer contributes reflects the employee's financial contribution. So, for instance, you might match 50% of an employee's contribution to their account up to 6% of their salary. Or, you could offer a dollar-for-dollar match up to 4% of their salary instead.
Employers aren't required to match employee contributions to their 401(k) plan, but many do as an added perk for their workforce.
The good news? If you offer employer matching at your startup, these expenses are tax deductible for your business. Just remember to stay within the IRS's guidelines on the total combined contribution limits for employees and employers.
Are employers required to make profit-sharing contributions?
A profit-sharing contribution is another type of 401(k) contribution that a company voluntarily makes to all eligible employee accounts.
Employees don't need to make a deferral or contribution to receive one of these contributions, either. A company may make regular contributions as part of a profit-sharing plan formula or decide on a yearly basis whether it wants to contribute to its employees' accounts.
Just like an employer 401(k) match, this type of contribution isn't a requirement for every company that offers a 401(k) plan, but it does provide benefits for the organizations that participate in it. Employees save more money for retirement, while the company can write these additional expenses off on its taxes.
How much does it cost a startup to set up a 401(k) plan?
The initial setup costs for a 401(k) plan can run anywhere from $500 to $2,000, depending on your chosen provider, the size of your startup, and the benefits you select. You may also need to take additional costs into account if you, say, transfer assets from an existing retirement plan to a new one or integrate your retirement plan with your payroll platform.
However, the SECURE Act offers two tax credits to relieve some of the financial burden of setting up a new retirement plan. Learn more about these tax credits on the IRS website.
How much does it cost to maintain a 401(k) plan?
If you're like most founders, you don't have the time, energy, or expertise to manage the complexities of your 401(k) plan in addition to all your other duties. So, you may decide to hire a third-party administrator to handle the plan's day-to-day operations for you.
These administration fees can range from $750 to $3,000 a year, with more complicated plans demanding higher costs.
401(k) plan administration made simple with Warp
As a startup serving startups, we know firsthand that keeping costs low while offering top-tier product offerings and white-glove service is a delicate balancing act. This is why we offer free benefits administration with our Pro and Premium plans --- so you can keep doing what you do best without sacrificing the well-being of your workforce.
And through our partnership with Guideline, the leading provider of 401(k) plans in the US, you can take advantage of a retirement plan solution that fully integrates with your payroll provider --- saving you time, money, and effort.
Learn more about our comprehensive benefit offerings by requesting a demo today.
