A 401(k) plan is a contribution-based retirement account that many employers offer to their employees.
Business owners should know that a 401(k) plan allows them to use their retirement funds to start or buy a business, and they can do so without incurring tax penalties or needing to take a loan.
A Closer Look at a 401(K) Plan
The plan is called the “401(k)” as its name is actually derived from a specific section of the Internal Revenue Code of the United States.
Simply put, the plan allows employees to contribute to their 401(k) accounts through payroll deductions. These are automatic. These contributions can also be matched in part or whole by their employers.
There are numerous advantages that a 401(k) plan provides. The main benefit is that it is tax-advantaged, meaning that investment earnings are not taxed until the employee withdraws the funds, which is usually after retirement. It’s good to note, though, that there are ways for it to be entirely tax-free. For example, all Roth 401(k) plan distributions may be fully exempt from taxes.
Employees who have a 401(k) plan are typically discouraged from withdrawing funds before they retire. Like other pre-tax retirement plans, using the funds prematurely can result in significant taxes and penalties. Some of these fines are as high as 50% of the total amount that was withdrawn.
However, not many business owners know that borrowing from retirement funds through a 401(k) plan provides better options than traditional business loans and business lines of credit. New entrepreneurs should be aware that 401(k) loans still require monthly payments, which can be pretty challenging for a young startup to manage.
This 401 (k) business financing option is also called Rollovers for Business Start-ups. Small business owners can use their retirement assets as working capital through ROBS, and they won’t face any withdrawal or tax penalties. In addition, it’s vital to note that there are no interest rates because this isn’t a loan. As a result, small business owners have a faster path to profitability and face a better chance of their business success.
The Different Types of 401(K) Plans
Business owners should also be aware of the importance of having the appropriate 401(k) plan for their company. This is because, with the correct 401(k) plan in place, they can save thousands of dollars in annual contribution costs.
Aside from saving money on expenses, having the correct 401(k) plan is important for a variety of reasons. Choosing the wrong type of 401(k) plan, for example, can lead to failed nondiscrimination testing. As a result, a slew of administrative issues may arise. In addition, the 401(k) plan can instead deter a business instead of helping it reach its goals.
401(k) plans can be complicated, which is why many business owners struggle to choose which type of 401(k) plan is ideal for their company or situation.
Before trying to get to know the various 401(k) plans, business owners must first be aware that there are no “types” of 401(k) programs. Instead, they should know that 401(k) are just very customizable.
This means that there aren’t many different kinds of 401(k) programs. Instead, various contributing factors can be introduced to a plan, and they can be combined in numerous ways.
Some Popular Small Business 401(K) Contribution Features
What are the most common combinations of contribution features since there are no distinct 401(k) “types”?
The five most popular contribution elements added to 401(k) plans by entrepreneurs are:
This enables a company to automatically enroll qualified employees who do not intend to make their own salary deductions for 401(k) contributions.
This combination of features enables a 401(k) plan to automatically allow a company to pass the ADP/ACP and other nondiscrimination standards.
To qualify for “safe harbor” status, a company must make a non-elective qualifying contribution for employees, or at the very least, match the contributions of current plan participants.
This combination of features allows a company to designate regular contributions to any plan participant. This is regardless of whether or not they make pre-tax or Roth salary contributions on their own or not.
This allows plan participants in this plan to make after-tax salary deferrals using the right combination of features.
This enables a small business to automatically match a percentage of its employees’ pre-tax or Roth salary deferrals.
Business owners need to note that the combination of features is highly dependent on the goals of the business. As a result, the features that comprise a 401(k) plan might vary considerably. One company may also have a very different set of features compared to another.
Some employers, for example, may opt to help their employees in maximizing their personal contributions. Others may choose to reward staff for their contributions through regular incentives.
What is important is that the objectives are clear so that the small business goals can be successfully aligned with the 401(k) plan design.