How to Start a 401(k) for Your Small Business

A 401(k) plan enhances a small business’s financial standing and offers a valuable employee benefit. These plans serve as a retirement savings vehicle, allowing both employers and employees to contribute pre-tax or Roth dollars that can grow tax-deferred until retirement. Establishing a 401(k) can attract and retain talent by providing a competitive compensation package, while also offering tax advantages for the business owner. Understanding the process of setting up and managing a plan is a foundational step. This guide clarifies plan types and the steps for establishment and administration.

Understanding Plan Options

Selecting the appropriate 401(k) plan type is a foundational decision, as each option has distinct characteristics regarding contributions, administrative complexity, and compliance. Four primary types are commonly available: Traditional 401(k), Safe Harbor 401(k), Solo 401(k), and SIMPLE 401(k). Each suits different business structures and objectives.

Traditional 401(k)

A Traditional 401(k) plan offers flexibility in plan design and employer contributions, which can be discretionary. For 2025, employees can contribute up to $23,500, with additional catch-up contributions for those aged 50 and older. The total combined employee and employer contribution limit is $70,000. Traditional plans are subject to annual non-discrimination testing by the IRS to ensure they do not disproportionately benefit highly compensated employees.

Safe Harbor 401(k)

A Safe Harbor 401(k) is a variation of the traditional plan designed to automatically satisfy most annual non-discrimination tests, such as the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests. This exemption is achieved by the employer making mandatory contributions, which are immediately 100% vested for employees. These contributions can be a dollar-for-dollar match on the first 3% of deferred compensation plus a 50% match on the next 2%, an enhanced match, or a non-elective contribution of at least 3% of each employee’s compensation, regardless of employee deferrals. Employee contribution limits are the same as for Traditional 401(k)s.

Solo 401(k)

The Solo 401(k), also known as an Individual 401(k) or Self-Employed 401(k), is designed for self-employed individuals or business owners with no full-time employees other than themselves and, potentially, their spouse. This plan allows contributions as both an employee and an employer. For 2025, the employee contribution limit is $23,500, with catch-up contributions for those aged 50 and older. As the employer, a business can contribute up to 25% of compensation, with overall combined contributions capped at $70,000, or higher with catch-up contributions, or 100% of compensation, whichever is less. This plan offers high contribution limits for maximizing individual retirement savings.

SIMPLE 401(k)

A SIMPLE 401(k) is for small businesses with 100 or fewer employees and cannot be offered if the employer maintains any other retirement plan. This simplified version of a traditional 401(k) features fewer administrative complexities and no non-discrimination testing. Employee contribution limits are generally lower, with a 2025 limit of $16,500, and catch-up contributions for those aged 50 and over. Employers must make contributions, either as a dollar-for-dollar match up to 3% of an employee’s pay or a non-elective contribution of 2% of each eligible employee’s pay, regardless of employee deferral. All contributions are immediately 100% vested for employees.

Preparing for Establishment

Establishing a 401(k) plan requires preparation, including collecting business and employee data, selecting a provider, and making plan design decisions. This phase ensures the plan aligns with business goals and regulatory requirements.

Gathering Accurate Business Information

Gathering accurate business information is a first step. This includes the Employer Identification Number (EIN), the business’s legal name and address, and details about its legal structure, such as sole proprietorship, partnership, S-corporation, or C-corporation. Information regarding the fiscal year-end is also necessary for proper plan administration and reporting.

Collecting Precise Employee Data

Collecting precise employee data is important for determining eligibility and shaping plan provisions. A comprehensive employee census should include full names, dates of birth, dates of hire, compensation, and hours worked for all employees. Classifying employees, such as full-time, part-time, or seasonal, is crucial as it impacts their eligibility for plan participation based on the chosen plan design.

Choosing a Suitable 401(k) Provider

Choosing a suitable 401(k) provider involves understanding the roles of various entities. Third-Party Administrators (TPAs) handle compliance testing, recordkeepers manage participant accounts and investments, and investment advisors offer guidance on investment options. When selecting a provider, businesses should consider the range of services, fee structure, and ability to integrate with existing payroll systems. Fees for 401(k) administration vary, typically including annual charges and investment fees.

Making Key Plan Design Decisions

Making key plan design decisions is part of the preparation process. These decisions, formally documented in the plan agreement, include establishing employee eligibility requirements, such as age and length of service. Employers must also decide on vesting schedules for employer contributions, which dictate when employees gain full ownership of those funds. Other considerations involve determining employee contribution types (e.g., pre-tax or Roth), establishing formulas for employer contributions, and deciding whether to include loan provisions or hardship withdrawal options.

Formalizing Your Plan

After preparatory work, the next stage involves formally establishing and launching the 401(k) plan. This phase translates decisions into operational realities, making the plan ready for employee participation.

Formally Adopting the Plan

Formally adopting the plan begins with signing the plan document and the adoption agreement with the chosen provider. The plan document is the legal blueprint, outlining the plan’s rules, while the adoption agreement tailors the master plan to the specific business. These documents ensure the plan complies with Internal Revenue Service (IRS) and Department of Labor (DOL) regulations.

Establishing Trust Accounts

Establishing trust accounts is a procedural step. These accounts are separate from the business’s operating funds and hold the plan’s assets, including employee and employer contributions. A trustee, often the plan provider, holds these assets for the benefit of plan participants. This separation of assets is a fundamental requirement for qualified retirement plans.

Informing Eligible Employees

Informing eligible employees about the new 401(k) plan and facilitating enrollment is part of the launch. This involves providing mandatory disclosures, such as the Summary Plan Description (SPD), which summarizes the plan’s features, and various fee disclosures. Clear communication helps employees understand benefits and how to participate. Employers should provide sufficient time for employees to review materials and make enrollment decisions.

Integrating the 401(k) Plan with the Business’s Payroll System

Integrating the 401(k) plan with the business’s payroll system is essential for accurate and timely contribution processing. This integration ensures employee deferrals are correctly withheld from paychecks and that both employee and employer contributions are remitted to the plan’s trust accounts promptly. Proper payroll integration streamlines ongoing administration and helps maintain compliance with contribution deadlines.

Managing Your Plan

Once a 401(k) plan is established, ongoing management is a continuous responsibility for the business owner. This involves administrative tasks and compliance requirements to ensure the plan remains in good standing and serves participants. Effective management maintains benefits and avoids penalties.

Ensuring Ongoing Contributions

Ensuring ongoing contributions are processed correctly is an administrative duty. This involves accurate deduction of employee deferrals from payroll and timely remittance of these funds, along with any employer contributions, to the plan’s trust account. The Department of Labor generally requires employee contributions be deposited as soon as administratively feasible, but no later than the 15th business day of the month following the month in which the amounts were withheld or received.

Annual Compliance Testing

Annual compliance testing is a recurring requirement for many 401(k) plans to ensure they do not disproportionately favor highly compensated employees (HCEs). Key tests include the Actual Deferral Percentage (ADP) test, which compares employee deferral rates between HCEs and non-HCEs, and the Actual Contribution Percentage (ACP) test, which examines employer matching and after-tax contributions. The top-heavy test also determines if too much of the plan’s assets are held by key employees. Failing these tests can result in corrective distributions or additional employer contributions to lower-paid employees.

Fiduciary Responsibilities

Fiduciary responsibilities are an aspect of managing a 401(k) plan under the Employee Retirement Income Security Act (ERISA). Fiduciaries, typically the business owner, must act solely in the best interest of plan participants and beneficiaries, exercising prudence in all decisions, diversifying investments to minimize risk, and adhering strictly to the plan documents. Fiduciaries can be held personally liable for breaches.

Annual Reporting Requirements

Annual reporting requirements include filing Form 5500 with the Department of Labor and the IRS. This form provides detailed information about the plan’s financial condition, investments, and operations. The specific version of Form 5500 required depends on the number of plan participants and the plan’s asset size. Plan administrators must also provide annual participant statements detailing account balances, vested percentages, and investment performance.

Processing Distributions and Rollovers

Processing distributions and rollovers for participants is an ongoing task. This involves handling requests for withdrawals due to retirement, termination of employment, or hardship, and facilitating rollovers to other qualified retirement accounts. Adhering to plan rules and IRS regulations regarding eligibility and taxation for these transactions is essential.

Amendments and Termination

Plans may require amendments due to regulatory changes, such as the SECURE 2.0 Act, or evolving business needs. The process for plan termination must also be understood, should the business decide to discontinue the plan. Both amendments and terminations involve specific procedural requirements and notifications.