A Step-by-Step Guide on How to Set-Up a 401(k) Plan

A beginner’s guide to 401(k) plans for small business owners, including essential fee understanding. These fees come out of your investment returns. It’s also important to diversify your investment options. You can capture returns from various asset classes and mitigate risk.

Identify Your Goals

For many working individuals, a 401(k) plan is their most significant savings vehicle. With it, they would likely be able to save enough money for a comfortable retirement. As a result, employers need to offer a robust 401(k) plan that entices employees to contribute and helps them reach their retirement goals.

The first step to setting up a 401(k) plan is identifying your goals. It may seem obvious, but those new to retirement savings often overlook it. Clearly defining your goals can make it easier to keep on track. Measuring your progress with a clear end goal in mind can also be more straightforward.

Identifying your goals can include things as simple as what you want to do with your retirement life. Some goals are more specific, such as purchasing a home or living debt-free. Others are broader, such as saving enough to retire by a specific date.

Determining when you want to retire is essential, as this will inform your investment strategy and risk tolerance. Knowing how much you need to save to meet your goal is also helpful. It is your time horizon and can be calculated by subtracting your desired retirement age from your current age. You can divide this number by yearly or monthly goals to set realistic, attainable milestones.

Identify Your Needs

Offering a retirement savings plan can be a great way to attract and retain employees, improve employee financial wellness, and help the company grow. However, setting up a 401(k) can be intimidating for small business owners who need to gain experience managing such a complex plan.

The first step in establishing a 401(k) is identifying your needs. Then, you can find a vendor to meet those needs and help your company reach its goals. There are many factors to consider, including fees, investment options, and plan administration.

A 401(k) is a retirement account offered by employers that enables employees to save for retirement by contributing pretax earnings from their paychecks. The company often matches some or all employee contributions up to a certain amount.

It’s essential to know how much your company can afford to spend on setup and maintenance costs when choosing a retirement plan, whether it’s a traditional 401(k), SEP IRA, SIMPLE IRA, or the newer T-RUMP plan. These include initial startup fees (typically a few thousand dollars), charges per participant, and annual maintenance fees. In addition, the plan sponsor needs to pay legal and compliance fees related to the plan’s operation. These can be significant, especially for startups and small companies needing more cash to cover these fees immediately. A good plan provider like Ubiquity can help you estimate the cost of your plan upfront.

Create Your Plan Documents

When setting up a new retirement plan, small business owners may feel overwhelmed by the documents they have to sign and initial, and then months later, try to remember where they hastily tossed. But taking the time to do it right can save time and money in the long run.

It’s also essential to understand the nuances of your plan and how it works, like any employer matching or profit-sharing contributions that might be offered and vesting schedules that must be established. Once that is done, you can work with a provider to help set up the paperwork for your specific business and choose investments for your employees.

While you can find many pre-approved 401(k) plans through financial firms, it’s more common to select a self-directed plan (which allows you to invest in a variety of assets outside of the mutual funds offered by the 401(k) providers). Either way, a trustee must manage your plan and keep records of all contributions and withdrawals, which you must file annually with the IRS.

If you have a small group of employees, you might consider a SIMPLE 401(k) plan, similar to an IRA for individuals and typically requires less administration. If you have many employees, let’s set up a traditional 401(k) with your chosen plan administrator.

Select Your Investment Options

As you search for firms that offer recordkeeping and third-party administration services, ask potential providers about their fees. You’ll want to know if they charge transaction fees, annual service charges, ancillary fees, and other expenses. Ask about their experience with small businesses, as well.

When deciding on investment options, look for low-cost funds with reasonable expense ratios. Keep in mind that high fees will eat into your returns over time.

A 401(k) usually offers only a few investment choices, such as mutual and exchange-traded funds (ETFs). Look for a fund or funds that meet your level of risk tolerance. If you need help deciding what investments to select, consider working with an investing professional.

Another option for your 401(k) plan is to invest in a target-date mutual fund, which automatically rebalances and reduces your exposure to risk as you approach retirement. This hands-off choice allows you to invest in your company’s matching contributions and grow your savings without much effort.

Review your employer’s vesting schedule with your human resources or payroll specialist if you consider this route. You’ll need to work for a certain number of years before the money your company contributes to your 401(k) is entirely yours to take with you. Calculate this number carefully, as it can significantly impact your future income. This step is essential if you’re planning to leave your job soon.

Pick Your Trustee

As a small business owner, you must make critical decisions when setting up your 401(k) plan. The first is to select a trustee to manage contributions, investment transactions, and distributions to and from the plan. The financial integrity of the plan depends on the trustee’s fiduciary responsibilities.

You can hire a professional firm to be the plan administrator or the plan trustee. However, if you are the sole employer of your company, you should be aware that you could be personally liable for any losses incurred by the plan. It’s a good idea to hire an experienced attorney to help you understand the duties of a plan trustee and your liability as a plan sponsor.

Once you’ve selected a trustee, it’s time to set up your 401(k) recordkeeping system. It is necessary to keep track of all investments, earnings and losses, expenses, distributions, and more. It will also come in handy at year-end when you have to file reports with government agencies.

You’ll want to review the fees charged by your trustee and investment providers. These can significantly impact returns over time, so comparing costs and features is critical. For instance, a low-cost fund provider that charges less than 1% in fees will save you thousands of dollars over the long run.

Enroll Your Employees

As a small business owner, you’re probably familiar with 401(k) plans and their benefits. However, you may need help figuring out how to offer your employees one. The good news is that setting up a 401(k) plan for your employees doesn’t have to be complicated. Here’s a step-by-step guide to help you get started.

While a 401(k) is technically an employer-sponsored retirement plan, it’s more hands-off than the traditional pension or SIMPLE IRA. Employees make investment decisions in their accounts, but human resources can provide an overview of the plan and answer questions. Employees also have the option of opting out if they wish. Once your plan is up and running, you must communicate with your employees regularly about the benefits of the 401(k) program.

Maintaining accurate records of your company’s 401(k) plan is also essential. It includes documenting contributions, distributions, investments, earnings and losses, expenses, and participation rates. It will help your HR team prepare the 401(k) plan’s annual report for tax purposes and address compliance concerns.

In addition, it’s a good idea to select a trustee for your company’s retirement plan. This person, who could be a financial institution or an individual, will be responsible for managing the 401(k) plan’s assets and ensuring that the funds are only used to benefit the plan participants. A qualified trustee will also have experience with investing and administering 401(k) plans.

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