401(k) Plans for Small Businesses

A 401(k) plan can be a powerful tool to promote financial security in retirement. A 401(k) plan provides a host of benefits for both employers and employees.  It can help an employer attract and retain employees.  An employer can make tax-advantaged contributions to the plan, and a 401(k) plan can include all employees, including owners, and managers. Employees also enjoy benefits, such as flexible contributions and investment options, tax-deductible contributions and tax-deferred earnings, and portability if they leave the company.

Establishing a 401(k) Plan

The first step in setting up a 401(k) plan is choosing the right professional advisor.  While a 401(k) plan may be simple in concept, it is more complicated than you think.  For example, there are different types of plans to choose from.

  • Traditional 401(k) plans offer employers the most flexibility. Employers can choose whether to make contributions on behalf of the plan’s participants, match employees’ deferrals, or both. However, traditional 401(k)_ plans are subject to annual nondiscrimination testing, which may limit the amount that owners and highly-compensated employees can contribute to the plan.
  • Safe harbor 401(k) plans are like traditional 401(k) plans except that the employer is required to make contributions on behalf of its employees.  The employer’s contributions can be matching for those employees who defer or made without regard to whether an employee makes deferrals.  Safe harbor 401(k) plans are not subject to annual nondiscrimination testing.
  • Automatic enrollment 401(k) plans automatically enroll employees in the plan and provides for a default deferral percentage and investment, unless the employee elects otherwise. This is an effective way for employers to increase the participation of non-highly compensated employees in their 401(k) plans.

There are four steps required to establish your 401(k) plan.

  1. Adopt a written plan document. The Internal Revenue Code requires that a qualified retirement plan, including 401(k) plans, have a written plan document.  The plan must be operated in accordance with the plan document.  There are some plan features that are required by law; others are optional.  Your professional advisor will help you with your plan document.  RMC has pre-approved, prototype documents that you can use.
  2. Arrange a trust fund for the plan’s assets. To ensure that a plan’s assets are used solely to benefit plan participants and their beneficiaries, the assets must be held in a trust.
  3. Develop a recordkeeping system. Maintaining a 401(k) plan requires accurate recordkeeping.  You must keep track of and properly allocate your employees’ contributions, as well as earnings and losses, plan investments, expenses and benefit distributions.  In addition, you will have to file annual returns/reports with the IRS or Department of Labor.  Your professional advisor will help you with these returns/reports.
  4. Provide plan information to employees eligible to participate. As plan sponsor, you have certain obligations to communicate with your employees.  You have to let them know about the existence of the plan, its benefits and features and whether they are eligible to participate.  In addition, you must provide your employees with a summary plan description (SPD).  The SPD is a summary of the features of the plan and its operation.  It is usually created at the same time as the plan document.  Your professional advisor will help you with the SPD.

Operating a 401(k) Plan

As plan sponsor, you have certain responsibilities in connection with the administration of your plan.  Your professional advisor will help you to carry out these obligations.


All eligible employees, including owners and highly-compensated employees, are given the opportunity to participate in a 401(k) plan.  However, you can exclude some employees from your plan, such as employees who are under 21, certain part-time employees and employees who are covered under a collective bargaining agreement.


All of the 401(k) plans discussed above allow employees to make elective contributions through salary deductions. In addition, employers can make contributions to the plan on behalf of their employees.

Traditional 401(k) Plan—As discussed above, an employer does not have to make contributions to a traditional 401(k) plan.  However, the plan is then subject to rigorous nondiscrimination testing.  If you decide to make contributions on behalf of your employees, the contribution can be a percentage of each employee’s compensation (a non-elective contribution) or a match of the amount that the employee contributes, or both.

Safe Harbor 401(k) Plan—A safe harbor 401(k) plan requires employer contributions.  The contribution can be a matching contribution limited to employees who make elective deferrals to the plan.  The employer’s match will equal 100% of the first 3% of the employee’s contribution and 50% of the employee’s contribution up to 5%.   In the alternative, you can make a non-elective contribution equal to 3% of compensation to each eligible employee whether or not the employee makes an elective deferral to the plan.  The benefit of a safe harbor 401(k) plan is that it is not subject to annual nondiscrimination testing.

Roth Contributions – 401(k) plans may, but are not required to, permit employees to make after-tax contributions to the plan.  These after-tax contributions are designated as Roth contributions.  Roth contributions are not tax-deductible, but they grow tax-free, and they are not subject to income tax upon withdrawal.

Contribution Limits – Contributions to a 401(k) plan are subject to annual limitations.  The combined limit for employer and employee contributions is the lesser of:

  • 100% of the employee’s compensation, or
  • $66,000 for 2023

In addition, employee elective deferrals to a 401(k) plan are limited to $22,500 for 2023. In addition, a 401(k) plan can permit employees over the age of 50 to make catch-up contributions of $7,500 for 2023.


Employee salary deferrals are immediately 100% vested—that is, the money that an employee has contributed cannot be forfeited. When an employee leaves employment, he or she is entitled to those deferrals, plus any investment gains (or minus losses). In safe harbor 401(k) plans, the employer’s contributions are also immediately 00% vested. In traditional 401(k) plans, the employer has the ability to adopt different vesting schedules.


In order to maintain its status as a qualified plan, a 401(k) plan may not discriminate in favor of owners or highly-compensated employees.  This is why traditional 401(k) plans are subject to annual nondiscrimination testing, which compares the participation and benefit levels of non-highly-compensated employees to those of owners and highly-compensated employees.  If a plan does not pass nondiscrimination testing, it may be required to refund a portion of the contributions made by owners or highly-compensated employees.

Investing 401(k) Plan Monies

Participants in a 401(k) are able to direct the investment of their money.  However, their choices are limited by the investment options selected by the plan sponsor.  This is a significant responsibility, and you will need the help of your professional advisor in selecting the investment options to be offered by your plan.

Fiduciary Responsibilities

As a plan sponsor, you are considered a fiduciary.  In addition, many of the advisors and other professionals that you hire to provide services to the plan may also be considered fiduciaries.  As a fiduciary, you and your advisors and service providers have the following responsibilities:

  • Act solely in the interest of the participants and their beneficiaries
  • Act for the exclusive purpose of providing benefits to workers participating in the plan and their beneficiaries, and defraying reasonable expenses of the plan
  • Carry out duties with the care, skill and diligence of a prudent person familiar with such matters
  • Follow the plan documents
  • Diversify plan investments

It is important that, as a fiduciary, you be familiar with the requirements of the laws governing the operation of a 401(k) plan.  You should consult legal and investment professionals to help you in carrying out these duties.

Disclosing Plan Information to Participants

As plan sponsor, you are required to provide certain notices to your employees to keep them informed about the basic operation of the plan, alert them to changes in the plan’s structure and operations, and provide them with a chance to make decisions about their accounts.

The summary plan description (SPD) is a plain-language explanation of the plan and must be comprehensive enough to apprise participants of their rights and responsibilities under the plan. It informs participants about the plan’s features and what to expect of the plan. This document must be given to participants when they join the plan and to beneficiaries when they first receive benefits. SPDs must also be redistributed periodically during the life of the plan.

A summary of material modification (SMM) alerts participants of changes made to the plan.  An SMM or an updated SPD must be automatically furnished to participants within a specified number of days after changes.

An individual benefit statement shows the total plan benefits earned by a participant, their vested benefits, the value of each investment in the account, information about the participant’s ability to direct investments, and an explanation of the importance of a diversified portfolio. Individual account statements must be furnished on a quarterly basis.

In addition, plan participants must receive the information needed to direct their investments. This includes providing plan and investment-related information, including information about fees and expenses. Participants need this information to make informed decisions about the management of their individual accounts. Participants must receive the information before they can first direct their investment in the plan and annually thereafter. The investment-related information needs to be presented in a format, such as a chart, that allows for a comparison among the plan’s investment options. A model chart is available.

A summary annual report (SAR) is a narrative of the plan’s annual return/report, Form 5500, filed with the federal government. It must be furnished annually to participants.

Reporting to Government Agencies

In addition to the participant disclosure documents, plans must also file certain governmental reports.

  • Form 5500 Annual Return/Report—Most plans are required to file an electronic annual return/report with the federal government, to disclose information about the plan and its operation to the IRS and the U.S. Department of Labor. These returns/reports are made available to the public. Most one-participant plans (sole proprietor and partnership plans) with total assets of $250,000 or less are exempt from the annual filing requirement.
  • Form 1099-R—This form is given to both the IRS and recipients of distributions during the year to report distributions (including rollovers) from the plan.
Distributing Plan Benefits

There are certain events that trigger an employee’s right to take distributions from the plan, such as retirement or termination of employment.  The amount of an employee’s benefit will depend on the employee’s account balance at the time of distribution, which, in turn, depends upon the employee’s contributions and investment experience. Most plans provide for a number of different forms of distribution, including a lump sum distribution, a rollover of the account to an IRA or other employer’s retirement plan, or the purchase of an annuity.

Terminating a 401(k) Plan

401(k) plans are intended to be permanent.  However, business needs may require that employers terminate their 401(k) plans—for example, if they want to establish another type of retirement plan instead.

Typically, the process of terminating a 401(k) plan includes amending the plan document, distributing all assets, and filing a final Form 5500. You must also notify your employees that the 401(k) plan will be discontinued.


Even with the best intentions, mistakes in plan operation can still happen. The U.S. Department of Labor and IRS have correction programs to help 401(k) plan sponsors correct plan errors, protect participants, and keep the plan’s tax benefits. These programs are structured to encourage early correction of the errors. Having an ongoing review program makes it easier to spot and correct mistakes in plan operations.

Join us on a journey to secure your retirement future! RMC has been at the forefront of crafting and nurturing retirement plans since 1974. Let’s take the first step towards a worry-free retirement together. Reach out to our dedicated Retirement Team today, and let’s start building your ideal retirement plan. Don’t wait any longer; dial 239-298-8210 or send an email to [email protected] now!

This article is not intended to be exhaustive, nor should any discussion or opinions be construed as professional advice. © 2015, 2018-2019 Zywave, Inc. All rights reserved.