How to Actually Set Up 401(k) for Employees – Avoid This Mistake + FAQs

To set up a 401(k) for employees, a small business owner must choose the right type of 401(k) plan, select a reputable plan provider, formalize the plan with required legal documents, and enroll employees while following all IRS and Department of Labor rules.

Are you a small business owner overwhelmed by the idea of offering a 401(k) to your team? You’re not alone. Only about one-third of U.S. small businesses offer a retirement plan for their employees, leaving a major opportunity for those who do to stand out and attract top talent. In this comprehensive guide, we’ll make setting up a 401(k) straightforward and rewarding. You’ll discover:

• Step-by-step guidance to launch a 401(k) program without breaking a sweat.
• Types of 401(k) plans (Traditional, Safe Harbor, Roth, SIMPLE, Solo, Automatic Enrollment) and which best fits your business.
• Federal requirements (and new state mandates!) you need to know to stay compliant.
• Comparison of top 401(k) providers to help you find the perfect fit.
• Common pitfalls that trigger headaches or penalties – and how to avoid them.

By the end, you’ll know exactly how to set up a 401(k) that secures your employees’ futures and gives your business a competitive edge. Let’s dive in!

The Benefits (and Drawbacks) of Offering a 401(k) Plan

Offering a 401(k) plan can be a game-changer for a small business. Before we get into the how-to, it’s important to understand why a 401(k) is worth considering, as well as the challenges it brings. Here’s a quick look at the pros and cons:

As you can see, the advantages are compelling—ranging from happier employees to tax breaks for you. The drawbacks mainly involve cost and responsibility, but recent laws (like the SECURE Act) have introduced credits and easier plan designs to help small businesses succeed.

In many cases, the benefits outweigh the hurdles, especially if you plan carefully and use the right support.

Types of 401(k) Plans for Small Businesses

Not all 401(k) plans are one-size-fits-all. There are several types of 401(k) plans, each with its own rules and ideal use cases. Choosing the right type is the first big step in setting up a 401(k) for your employees. Let’s break down the main options:

Traditional 401(k) – The Standard Plan

A traditional 401(k) is the most common type of plan. Employees contribute a portion of their paycheck pre-tax, which means their contributions reduce their taxable income now (and they’ll pay taxes on withdrawals in retirement). Employers may choose to match a portion of employees’ contributions or make other contributions, but it’s not required.

Key features of a traditional 401(k):

• Flexibility: You can decide whether to offer an employer match and set a vesting schedule (how long employees must work to own 100% of employer contributions).
• Contribution limits: Employees can defer up to a certain limit each year (for example, $22,500 for 2024, with an extra $7,500 catch-up if age 50+). Employer contributions are also limited, with a combined employer+employee cap (over $60,000 per year).
• Nondiscrimination tests: Traditional plans must pass IRS tests to ensure they don’t unfairly favor owners or highly compensated employees. If rank-and-file employees don’t participate enough, high earners’ contributions might be capped or partially refunded.

Traditional 401(k)s are powerful but come with the responsibility of annual testing. They work well for businesses where you expect decent participation across all employees or are willing to manage the plan to pass the tests.

Safe Harbor 401(k) – Skip the Testing, Keep the Perks

A Safe Harbor 401(k) is designed to automatically satisfy those IRS nondiscrimination tests. In exchange, you as the employer agree to contribute to your employees’ 401(k) accounts in a specific way. Safe Harbor plans require either:

• Matching: e.g., dollar-for-dollar match up to 3% of pay, and maybe $0.50 on the dollar for the next 2% (one common formula), or
• Nonelective contribution: e.g., give every eligible employee 3% of their salary into the plan, whether or not they contribute themselves.

These contributions in a Safe Harbor plan must vest immediately (employees instantly own that money).

The big benefit: if you meet Safe Harbor rules, you skip the annual nondiscrimination testing. This means owners and high earners can contribute the maximum allowed to their 401(k) without worrying about having to pull money out due to low participation rates among others.

Safe Harbor 401(k)s are popular with small businesses that have highly compensated owners or employees who want to max out contributions. The guaranteed contributions cost the company money, but you might view it as an investment in employee benefits (and it’s tax-deductible).

Plus, Safe Harbor plans can include additional profit-sharing contributions if you choose, giving flexibility to reward employees when the business does well.

Roth 401(k) – Tax-Free Growth for the Future

A Roth 401(k) is not a separate plan, but rather a feature you can add to any 401(k) type (Traditional or Safe Harbor).

With a Roth 401(k) option, employees contribute after-tax dollars (no immediate tax break on their paycheck). In return, those contributions grow tax-free, and withdrawals in retirement are tax-free as well (as long as certain conditions are met).

Key points about Roth 401(k)s:

• Employees can choose Roth, traditional (pre-tax), or a combination for their contributions. This gives flexibility based on personal tax situations.
• No income limits: Unlike Roth IRAs, a Roth 401(k) does not have income restrictions. High earners can contribute to a Roth 401(k).
• Employer contributions, if any, must go into a traditional pre-tax account even if the employee chooses Roth for their own money (the employer money is always pre-tax).
• Roth contributions count toward the same annual limit as traditional 401(k) contributions. It’s just the tax treatment that differs.

Offering a Roth 401(k) option can make your plan more attractive, especially to younger employees or those who expect to be in a higher tax bracket later. It lets them lock in tax-free income in retirement. Many small businesses offer both pre-tax and Roth choices under their 401(k) plan for maximum flexibility.

SIMPLE 401(k) – Simplified Plan for Small Employers

A SIMPLE 401(k) is a bit of a hybrid between a traditional 401(k) and a SIMPLE IRA. “SIMPLE” stands for Savings Incentive Match Plan for Employees. It’s only available for businesses with 100 or fewer employees.

The goal of a SIMPLE 401(k) is to provide an easier, lower-cost way to offer a retirement plan, but it has some limitations:

• Like Safe Harbor, employer contributions are mandatory: either a matching contribution (generally up to 3% of pay) or a 2% nonelective contribution for all employees. These must vest immediately.
• No nondiscrimination testing is required (the plan design satisfies the requirements if you follow the rules).
• Lower contribution limits: Employees can defer less than in a standard 401(k) (for example, $15,500 per year, plus a smaller catch-up for 50+). This is similar to the limits of a SIMPLE IRA, and lower than the regular 401(k) limit.
• You cannot offer any other retirement plan (like another 401(k) or pension) in the same year you have a SIMPLE 401(k).

SIMPLE 401(k)s are not very common because many small businesses opt for a SIMPLE IRA if they want simplicity, or a Safe Harbor 401(k) if they want higher limits.

However, a SIMPLE 401(k) could be a fit if you want a 401(k)-style plan with minimal testing and are okay with the lower limits. It can also allow loans to participants (SIMPLE IRAs do not), which is a unique perk of the 401(k) format.

Solo 401(k) – For the One-Person Business

A Solo 401(k) (also called an Individual 401(k)) is a traditional 401(k) plan that covers only one person (or a person and their spouse who co-owns the business). If you have no employees (other than possibly your spouse), a Solo 401(k) lets you maximize retirement savings by essentially wearing two hats:

• As the employee: You can defer up to the normal annual 401(k) limit ($22,500, plus catch-up if eligible).
• As the employer: Your business can contribute additional funds, up to 25% of your compensation, as a profit-sharing contribution.

Combined, these can allow a self-employed person to save a lot each year (the total cap for 2024 might be around $66,000 or more, depending on age). Solo 401(k)s can be Roth or traditional as well, if the provider supports it.

They also avoid nondiscrimination testing because there are no other employees to compare with.

Important: The moment you hire any eligible employees, your Solo 401(k) would need to convert to a regular 401(k) plan covering them or be terminated. But until then, it’s an excellent tool for a one-person company to save for retirement aggressively.

Automatic Enrollment 401(k) – Boosting Participation Effortlessly

Automatic enrollment isn’t a separate 401(k) plan type, but a feature you can adopt in any 401(k) plan (traditional or Safe Harbor). With automatic enrollment, you set a default contribution rate (e.g., 3% of salary) to automatically deduct for each employee who is eligible. Employees have the choice to opt out or change the rate, but if they do nothing, they’ll be enrolled by default.

Why consider automatic enrollment?

• Higher participation: Many people intend to save but never get around to signing up. Auto-enroll puts them in the plan by default, dramatically increasing participation rates (which helps with those nondiscrimination tests).
• Auto-escalation: Plans often pair auto-enrollment with auto-escalation, which means increasing the contribution rate by 1% each year (usually up to a cap like 10%). This helps employees gradually save more over time.
• Employer obligations: If you auto-enroll, you have to provide proper notices to employees and manage anyone who opts out. Also, some states or future federal rules might require new plans to include auto-enrollment by default (for example, under federal law starting in 2025, many new 401(k) plans will need to have auto-enrollment at 3% or more).

Automatic enrollment can be a smart move, especially if you want to foster a culture of saving and ensure your plan’s success. It’s something to decide when setting up the plan.

Note that if you use auto-enrollment in a traditional 401(k), there’s a special type of Safe Harbor called a QACA (Qualified Automatic Contribution Arrangement) Safe Harbor, which has slightly different minimum contributions and vesting rules—but that’s an advanced topic. The takeaway: auto-enrollment can be added to virtually any plan to make it more effective.

Now that we’ve covered the menu of 401(k) types and features, let’s get into the actual steps to create a plan for your business.

Step-by-Step Guide: Setting Up a 401(k) Plan for Your Employees

Setting up a 401(k) might sound complicated, but it can be broken down into clear steps. Here’s how you can go from zero to a fully functioning retirement plan:

Step 1: Assess Your Business’s Needs and Goals

Before diving into paperwork, think about what you and your employees need from a 401(k):

• Budget for contributions and fees: Decide how much your business can afford in terms of matching contributions or plan administration fees. For example, can you contribute a match, or do you prefer not to? Knowing this will guide your plan type and provider choice.
• Employee interest: Gauge your team’s interest in a retirement plan. If you have employees asking about it, that’s a good sign. High interest might mean a traditional plan could pass testing, whereas low interest might push you to Safe Harbor or auto-enrollment to ensure participation.
• Owner’s objectives: If you (and any co-owners) want to maximize your own contributions, that might lean you toward Safe Harbor, which allows you to contribute the max without testing headaches. If you’re simply looking to provide a basic benefit and not contribute much yourself, a traditional plan or even considering alternatives like a SIMPLE IRA could suffice.
• State mandates: Check if your state requires you to offer a retirement plan once you have a certain number of employees (more on that below in the state mandates section). If so, that’s an extra push to set one up sooner than later.

Clarifying these points will make the next steps easier. It’s like laying out a blueprint before building a house.

Step 2: Choose the Right 401(k) Plan Type

Based on your assessment, decide which type of 401(k) suits you best. Refer back to Types of 401(k) Plans above for details on each. In short:

• If you want simplicity and don’t mind contributing for employees every year, a Safe Harbor 401(k) can be a great choice to avoid testing.
• If you have no employees yet (or only your spouse), a Solo 401(k) is the way to go.
• If you want to offer Roth contributions or automatic enrollment, ensure any plan you choose allows those features (most providers can include them if you ask).
• If you have a very small team and can’t afford a regular 401(k) yet, you might consider a SIMPLE 401(k) or even a SIMPLE IRA as a temporary stepping stone. But remember, a SIMPLE IRA isn’t a 401(k) – it’s a different type of plan with its own rules (and it would satisfy state mandates too if applicable).
• If you’re unsure, many small businesses start with a Safe Harbor plan for peace of mind, or a traditional 401(k) if they’re confident in employee participation.

Choosing the plan type is crucial because it will influence your costs, administrative work, and how much everyone can contribute. It’s okay to consult a financial advisor or a retirement plan consultant at this stage if you need guidance tailored to your situation.

Step 3: Select a 401(k) Provider or Administrator

You don’t have to (and generally shouldn’t) run a 401(k) plan all by yourself. Selecting a good 401(k) provider is key. Providers include financial services companies (like fund companies or banks), insurance companies, brokerage firms, or specialized 401(k) administration firms.

They will handle the heavy lifting: setting up the plan documents, keeping track of contributions and investments, and helping with compliance tasks.

When choosing a provider, compare factors like:

• Fees: Look at any setup fees, annual administrative fees, and per-participant fees. Some providers charge the employer, some fees can be paid from plan assets, and some newer providers have flat pricing which can be budget-friendly.
• Investment options: Ensure they offer a range of solid investment funds (index funds, target-date funds, etc.) with low expense ratios. Providers like Vanguard or Fidelity, for example, are known for wide fund selections.
• Payroll integration: If a provider integrates with your payroll system, it reduces manual work. For instance, providers like Guideline or Human Interest integrate with many popular payroll services to automate contributions each pay period.
• Ease of use and support: Small business owners need a provider that offers good customer service and an easy platform, since you may not have a dedicated HR person. Reading reviews or getting referrals from other business owners can help.
• Plan design support: A good provider will help tailor the plan (like setting up Safe Harbor provisions or auto-enrollment features if you want them) and keep you compliant with notices and testing.

Take your time to shop around. Request demos or proposals from a few providers. Below is a quick comparison of some top 401(k) providers popular with small businesses:

Choosing a provider is a big decision, but remember you’re not locked in forever—if your first choice doesn’t work out, you can change providers later. Just aim for one that fits your budget and gives you confidence that your plan will be well-managed.

Step 4: Design Your Plan Details

Once you’ve picked a provider, you’ll work with them to customize your 401(k) plan. This involves making decisions on:

• Eligibility: Decide which employees can join and when. Many plans allow employees to join after 3 months of service or a year at most. (Recent law changes require that long-term part-time employees—those working 500+ hours for 3 consecutive years—be allowed to participate, so plan accordingly.)
• Contributions: Set your employer contribution policy. Will you match employee contributions? If so, what formula (e.g., 4% match on 5% of salary)? Or will you do profit-sharing or nonelective contributions? You can also opt not to contribute (except if you chose a Safe Harbor or SIMPLE, then you have to follow those contribution rules).
• Vesting schedule: If you have employer contributions, decide if they vest over time. Vesting means employees earn the right to keep employer contributions by staying employed. For example, you might have a 3-year “cliff” vesting (100% vested after 3 years, 0% before that) or a graded vesting (20% vested after 1 year, 40% after 2, … 100% after 5 years). Safe Harbor and SIMPLE 401(k) contributions must be 100% immediately vested, by law. For other plans, vesting is a tool to encourage retention.
• Investment options: Your provider will have a menu of funds. You should select a diversified lineup (often the provider helps or has a default lineup). Typically, including target-date retirement funds is good so employees who are not investment-savvy can just pick a fund near their retirement year. Make sure the funds have reasonable fees.
• Loans or withdrawals: Decide if your plan will allow loans and hardship withdrawals. 401(k) loans let employees borrow from their account and pay it back, which some appreciate. Not all small plans allow loans because it adds complexity, but it can be a valued feature.
• Automatic features: If you want automatic enrollment or auto-escalation, specify the default percentage and escalation rate. The provider can help ensure you meet notice requirements for these features.

All these choices will be documented in your plan document, a legal document that outlines the plan’s rules. Your provider or a third-party administrator will usually prepare this for you, but you will need to provide the inputs (i.e., make the decisions).

The plan document is like the rulebook for your 401(k). Once it’s set up, you will also need to formally adopt it (usually by signing an adoption agreement).

Step 5: Handle the Legal and Compliance Steps

Setting up a 401(k) has some one-time legal steps. Don’t worry—your provider will usually guide you through these, but you should know what they are:

• Adopt the written plan: As mentioned, you (the employer) sign the plan documents to officially establish the 401(k) plan. Keep a copy of this document safe.
• Apply for an Employer Identification Number (EIN) if needed: If you don’t already have an EIN for your business (required to sponsor a 401(k)), get one (most businesses already have this for tax filings).
• Plan setup with IRS/DOL: Most 401(k) plans need to be reported to the government. Typically, you’ll file a Form 5500 each year (an annual report on the plan) once the plan is running. You don’t have to individually “register” the plan at setup except to maintain records and start filing when due. However, if your plan uses a pre-approved plan document (most do), the heavy lifting of IRS approval is already handled by the provider who got it pre-approved.
• Trust account: 401(k) assets must be held in a trust (to protect the money for the participants). Your provider or a financial institution will set this up, which is basically the account(s) where all contributions go. Each participant will have their own account within the plan trust.
• Fidelity bond: ERISA (the federal law governing retirement plans) requires a fidelity bond for plan fiduciaries. This is an insurance that protects against fraud or misuse of the plan’s funds. You’ll need to obtain a bond (often equal to 10% of plan assets, with a minimum like $1,000 up to a max of $500,000). Many providers will remind you of this or include assistance in getting one. It’s usually not expensive for a small plan.

These steps ensure your plan is legally in place. It might seem like a lot, but if you have a good provider, most of this is standardized.

Step 6: Enroll Your Employees and Launch the Plan

Now for the exciting part—getting your employees on board. Once the plan documents are signed and the plan is effective (you can choose a start date, often the beginning of a month or quarter), you can enroll participants.

• Employee communication: Notify your employees about the new 401(k) plan. Provide them with information about how the plan works, the benefits of participating, and any key dates. Your provider often has template announcement emails or flyers. Make it clear if you are offering a match, as that’s essentially “free money” for them if they contribute.
• Enrollment period: Give employees the forms or online links to enroll. They’ll need to decide how much to contribute (what percentage of their pay) and choose their investments (or accept default investments if your plan uses a default like a target-date fund for those who don’t choose).
• Automatic enrollment handling: If you chose automatic enrollment, this process is slightly different: you will inform employees that they will be automatically enrolled at X% unless they opt out by a certain date. Ensure you follow the notice rules (again, providers supply these).
• Beneficiary forms: Have employees designate beneficiaries (who will inherit their account if something happens). This is a standard part of enrollment.
• Set up payroll deductions: Work with your payroll administrator or software to start withholding the 401(k) contributions from each participating employee’s paycheck. This is critical—once an employee elects a contribution, each pay period you must deduct that percentage of their pay and send it to the plan’s trust account.
• Initial contributions: Fund the plan. The first contributions may include both employee deferrals and any employer contributions (if you chose to contribute from the start). Make sure these get deposited into the plan trust timely. (Tip: The IRS and Department of Labor have rules on how quickly you must deposit employee contributions—generally as soon as feasible, but small plans get a safe harbor of 7 business days after payroll. Don’t hold onto the money.)

When the plan is up and running, take a moment to congratulate yourself. You’ve just provided your employees (and yourself) a major benefit that not only helps with retirement but also signals that your business is growing and forward-thinking.

Step 7: Maintain and Monitor the Plan

Setting it up is half the battle—maintaining the plan is the other half. Make sure you:

• Stay compliant: Mark your calendar for key annual tasks. Typically, you’ll need to file the Form 5500 each year (which your provider or TPA often prepares for you to sign). If you have a traditional 401(k), you’ll go through nondiscrimination testing annually (usually done by the provider; you just provide payroll data). If something fails, the provider will guide you on corrections (or you can switch to Safe Harbor next year to avoid it).
• Provide required notices: Safe Harbor plans require an annual notice to employees each year before the start of the new plan year (outlining the contribution formula, etc.). Automatic enrollment plans also require notices. Make sure to use any templates your provider has and send them on time.
• Deposit contributions promptly: Late deposits of employee contributions are a common mistake and can lead to penalties. Set a process so that after each payroll, contributions are sent to the provider right away.
• Monitor investments and fees: As a fiduciary, you should review the plan’s investment options and fees periodically (say, once a year) to ensure they are reasonable. You don’t have to constantly tinker, but be aware if any fund is performing poorly or if fees could be lowered by switching to a different share class or fund. Many plans set up an Investment Policy Statement and have an annual review meeting (even if it’s just you and perhaps an advisor or the provider’s rep).
• Keep good records: Maintain records of plan documents, amendments, adoption agreements, and communications. If the IRS or DOL ever audits your plan, you’ll want these handy. Also, keep track of who is in the plan, who opted out, etc., which your provider’s reports will show.
• Educate and encourage: Ongoing education for employees can help keep participation high. Consider having an annual or semi-annual meeting where your provider or an advisor educates employees about saving for retirement, the power of compound interest, etc. This helps everyone get the most out of the plan.

Administering a 401(k) is an ongoing responsibility, but with a good setup and routine, it becomes part of the rhythm of running your business. Many tasks will be automated or handled by your provider, especially if you integrate with payroll.

Next, let’s ensure you understand the broader rules you’re operating under—federal laws that govern all 401(k) plans—and then look at those state mandates that might apply to your business.

Federal Requirements and Compliance (What You Must Know)

401(k) plans are subject to several federal laws and regulations. As a plan sponsor, it’s critical to be aware of these requirements to keep your plan in good standing:

• ERISA: The Employee Retirement Income Security Act of 1974 is the primary law governing retirement plans. It sets standards to protect participants – things like fiduciary duty, reporting requirements, and fairness. Under ERISA, you as the plan sponsor and any other plan fiduciaries (like a plan administrator or investment committee, if you have one) must act in the best interest of plan participants and beneficiaries.
• That means choosing prudent investments, keeping fees reasonable, and following the plan terms.
• IRS Contribution Limits: The IRS sets dollar limits on contributions. These can change year to year with inflation. For example, in 2024 an employee’s elective deferrals are limited to $22,500 (or $30,000 if age 50+ with catch-up).
• Total contributions (employee + employer) might be limited to around $66,000 per employee (or higher with catch-ups). As the sponsor, you need to ensure no one goes over these limits. (Your provider’s system usually helps track this automatically).
• Nondiscrimination Tests: If you don’t have a Safe Harbor plan, each year you’ll perform tests like ADP/ACP (Actual Deferral/Contribution Percentage) and a Top-Heavy test. These compare contributions of average employees vs. highly compensated employees (HCEs, typically those earning above a certain threshold or owning more than 5% of the company).
• Failing a test isn’t criminal, but you must fix it (often by refunding excess contributions to HCEs or making extra contributions to non-HCEs). Safe Harbor plans avoid ADP/ACP, but still require a Top-Heavy test (which is usually passed automatically if you’re meeting Safe Harbor contributions).
• Fiduciary Responsibility: As mentioned under ERISA, you have a duty to run the plan prudently. This includes monitoring investment options for performance and fee reasonableness. For example, if your plan offers only a very expensive mutual fund when cheaper similar funds are available, that could be a breach of fiduciary duty.
• There have been court cases where employees sued employers for having high-cost investments in the 401(k) (often these are big company plans, but the principle applies to all). Always remember: the money in the plan is the employees’ money, even if you have control over the choices.
• Reporting and Disclosure: You must file an annual Form 5500 (for plans with any assets; very small one-participant plans have a different simple filing if assets are under $250k). This form is a public record of the plan’s basic info and financial status.
• You also need to distribute certain information to participants: summary plan description (SPD) when they join, annual fee disclosures (so they know what fees they pay), and any Safe Harbor or automatic enrollment notices required by law.
• Timely Deposits: The Department of Labor requires that employee deferrals be deposited to the plan trust as soon as reasonably possible. For small plans (under 100 participants), depositing within 7 business days is deemed compliant. Don’t treat employee contributions like company assets – they must get into the employees’ accounts quickly. Late deposits can result in having to make up lost investment earnings and reporting to DOL.
• Plan Audits: If your plan grows to 100 or more participants, you’ll need an independent audit as part of the Form 5500 filing each year. This likely won’t apply at startup, but be aware as you grow.
• SECURE Act changes: Recent legislation (SECURE Act 1.0 in 2019 and SECURE 2.0 in 2022) introduced many small business-friendly rules. For instance, small businesses can now get a start-up tax credit covering 100% of plan setup and admin costs for the first 3 years (up to $5,000 per year) if you have at most 50 employees, and 50% of costs for 51-100 employees.
• SECURE 2.0 also added a credit for employer contributions for the first few years and the $500 credit for adding auto-enrollment. Another change: from 2025 onward, new 401(k) plans will be required to auto-enroll employees at 3% (escalating annually to 10%) unless the business has 10 or fewer workers or is a new company (under 3 years old). This means if you start a plan in 2025 or later and have more than 10 employees, you’ll likely need to include that auto-enrollment feature.
• Participant Rights: Employees are generally allowed to roll over money into the plan (from other retirement accounts) and roll out money when they leave (to an IRA or new employer’s plan).
• You can’t force them to keep money in your plan beyond certain limits, and you must distribute required minimum distributions (RMDs) for older participants as the law dictates. Also, employees are protected from being fired just to prevent them from getting plan benefits—that’s an ERISA no-no.

It sounds like a lot of rules, but providers and possibly your company’s CPA or benefits advisor can help ensure you’re meeting these requirements. The key is to be aware and choose a plan design that makes compliance easier (Safe Harbor, using auto-enroll, etc., can all streamline compliance).

One more critical area to consider: the interplay of your plan with state laws. Specifically, some states have started requiring employers to offer a retirement plan. Let’s explore that next.

State Retirement Plan Mandates (Is Your Business Affected?)

In addition to federal rules, you should check if your state has its own mandate for retirement plans. Over the last few years, many U.S. states have implemented (or are planning) programs that require businesses of certain sizes to offer a retirement savings option – either a private plan like a 401(k) or the state’s own program (usually a Roth IRA program). These state programs are often automatic-enrollment IRAs that employees can contribute to if no employer plan is available.

Here’s a breakdown of some state-level mandates currently in place or coming soon. If your business operates in one of these states (and meets the criteria), you’ll need to either set up a 401(k) or another qualified plan, or register for the state’s program to comply with the law:

How to use this table: If your state is listed and you meet the criteria (usually based on number of employees and whether you already offer a plan), you have a legal requirement to take action.

In most cases, if you set up your own 401(k) plan, you are exempt from the state program – which is a big incentive to have your own plan, so you can control the quality and features for your employees (state programs typically only allow employee contributions, with no employer match, and limited investment options).

For example, in California, if you have 10 employees and no retirement plan, you must either start one (like a 401(k) or IRA plan) or enroll in CalSavers. If you start your 401(k) as we’re discussing, you’d simply notify CalSavers that you’re exempt because you have a plan.

These state mandates are aimed at closing the retirement savings gap. As a small business owner, it’s good to know if any apply to you so you can stay compliant and avoid fines. But instead of seeing it as just an obligation, consider that by setting up a 401(k) proactively, you not only comply but also gain the benefits we discussed earlier (tax credits, happier employees, etc.), which the state program typically doesn’t give you.

Real-Life Scenarios: Choosing the Right 401(k) Approach

Every small business is unique. Here are a few scenarios illustrating how different companies might implement a 401(k) plan, given their situation:

These scenarios show that the best solution depends on factors like number of employees, budget, and company goals. The great thing about 401(k) plans is their flexibility — there’s usually a way to tailor a plan to fit your needs, whether that’s super simple or more sophisticated.

Steer Clear of These 401(k) Pitfalls 🚩

While setting up a 401(k) can bring many positives, there are also common mistakes and pitfalls that small business owners should avoid. Learn from others’ experiences and keep your plan running smoothly by steering clear of the following:

1. Procrastinating on deposits and paperwork: Once your plan is live, never delay depositing employee contributions. For instance, if payday is the 1st, aim to have contributions in the plan within a week – not next month! Similarly, don’t neglect required filings like the annual Form 5500; missing deadlines can lead to penalties, so set calendar reminders or use your provider’s alerts to stay on track.
2. Choosing high-fee providers or funds: Not all 401(k)s are created equal. If you choose a provider with excessive fees or fill the plan with expensive, underperforming funds, everyone loses. Always compare fees and offer low-cost investment options. Remember, as a fiduciary you should monitor plan fees (some employers have been sued for not doing so). Keep an eye on costs and switch providers or funds if needed.
3. Ignoring plan notices and amendments: Laws change and plans need updates. If your provider sends you an amendment to sign or asks you to distribute a notice to employees, don’t ignore it (for example, auto-enrollment plans require annual notices). Failing to follow these requirements could jeopardize your plan’s compliance or result in penalties. Stay organized and respond promptly.
4. Not educating your employees: Just offering a 401(k) isn’t enough; employees need to understand it. Without clear communication, some might not enroll or could make poor decisions. Hold a plan orientation or workshop and encourage questions. In one real case, a nonprofit failed to inform an employee how to enroll—she missed out on years of contributions and even took legal action.
5. Setting and forgetting the plan: A 401(k) is not a “set it and forget it” benefit. Businesses evolve – you might hire more people or see your finances change – so review your plan each year. Check if your match (if any) is still affordable and competitive, if the default investments are performing well, and if your plan design needs any updates due to growth or new laws. Regular check-ups keep your 401(k) valuable and compliant.
6. Failing to seek expert help when needed: You wear many hats, but retirement law can get technical. Don’t hesitate to seek advice from a financial advisor, CPA, or ERISA attorney if needed. For example, if you attempt a complex profit-sharing allocation or discover a plan mistake, professional guidance can save you from costly errors. The IRS has correction programs for plan mistakes, but you must follow proper steps, so expert help ensures issues are fixed correctly and your plan stays on track.

Avoiding these pitfalls comes down to being diligent and proactive. With the right approach, you won’t just set up a 401(k); you’ll manage it successfully for years to come.

Frequently Asked Questions (FAQ)

Q: Do I have to offer a 401(k) to my employees?
A: No, federal law doesn’t require employers to offer a 401(k). However, some states do mandate a retirement plan (or use of a state program) once you have a certain number of employees.

Q: Is a 401(k) worth it for a very small business (like under 10 employees)?
A: Yes, even very small businesses can benefit. A 401(k) helps attract and retain employees and offers the owner big tax-advantaged savings. New tax credits can cover most of the startup costs.

Q: Can I set up a 401(k) if I’m self-employed with no employees?
A: Yes, you can establish a Solo 401(k) for yourself (and your spouse, if involved). It lets you make both employee and employer contributions, allowing for a high level of retirement saving.

Q: Are we required to match employee 401(k) contributions?
A: No, a standard 401(k) doesn’t require an employer match. Matching is optional (except in Safe Harbor or SIMPLE plans, where a certain contribution is required). Many employers do match to encourage participation, but it’s up to you.

Q: Is it expensive to set up and run a 401(k) plan?
A: No, many low-cost 401(k) providers charge only a few hundred dollars to set up plus a small monthly fee per employee. With tax credits up to $5,000/year, a plan can essentially pay for itself.

Q: Can part-time employees participate in our 401(k)?
A: Yes, if they meet your plan’s eligibility (e.g., one year of service). By law, anyone working 1,000+ hours/year (and now long-term 500-hour part-timers) must be allowed to participate.

Q: Can I skip employer 401(k) contributions in years we can’t afford them?
A: Yes, you can usually skip or reduce employer contributions if money is tight, as long as your plan isn’t a Safe Harbor or SIMPLE (which require set contributions). Traditional 401(k)s give you discretion each year.

Q: Can I change providers or plan types later on?
A: Yes, you can switch providers or plan types later. Many companies start with a basic plan and later move to a Safe Harbor 401(k). Just plan the timing carefully to avoid any interruptions.

Q: Do 401(k) contributions really make a difference for my taxes?
A: Yes, 401(k) contributions are tax-advantaged. Employee deferrals lower their taxable income (unless they choose Roth), and employer contributions are deductible. Owners can significantly reduce their own taxable income by contributing.