By setting up a 401(k) plan, the employers can save tax benefits and help their employees save for retirement. The 401(k) plans are not just meant for well-established organizations and large businesses with ample capital. Start-ups, small and medium-sized businesses can also adopt a 401(k) retirement plan.
Understanding a 401(k) Plan
A retirement plan such as a 401(k) is a savings option that lets employers and employees deposit a portion of their pre-tax salary into their retirement funds. By depositing a small contribution from the salary to the retirement funds, one can grow their savings into a considerable amount that can be utilized after retirement. As all contributions to the 401(k) plan are pre-tax, employees can enjoy a reduced tax burden in the short term while their investments grow over time in a tax-free environment.
What are the Benefits of a 401(K) Plan?
All 401(k) retirement plans allow employers and employees to enjoy significant benefits. These benefits include:
- Comparatively higher savings than an Individual Retirement Account or IRA.
- Ability to contribute a maximum of 25% of the employee’s salary to retirement funds.
- Substantially high contribution limits for employers and employees in comparison to a traditional IRA. For example, if an amount of $19,000 is contributed in 2020 to a 401(k) plan, this limit is raised to $19,500 in 2021. In comparison, through a traditional IRA the maximum contribution limit would remain the same at $6000 in both 2020 and 2021.
Types of 401(k) Plans
The different types of 401(k) retirement plans include:
Small Business 401(k): This plan is just like any large business 401(k) plan and allows you to make pre-decided contributions toward retirement savings from the pre-tax income. The limits for maximum contribution remain the same and are not affected by the number of employees. This plan is free of asset management charges and is simple to handle. Hence, it is best suited for startups and small businesses.
Individual 401(k): The individual retirement plan is designed for self-employed individuals or businesses with a sole-proprietor. It is also known as the self-employed or solo 401(k) plan. This plan is simple to handle for individuals and provides similar flexibility and savings benefits like other 401(k) plans.
Self-Directed 401(k): This plan offers automated salary deductions and provides similar pre-tax savings just like any traditional 401(k) plan. The benefit of choosing a self-directed 401(k) plan is that it gives you the ability to select where to invest your funds.
SIMPLE 401(k): This plan is a blend of IRA and the traditional 401(k) plan and has similar provisions allowing owners and employees to borrow money against the retirement savings. One of the main advantages of this plan is that employers do not need to worry about the annual IRS testing since this plan is compliant with the non-discrimination tests. The only disadvantage of this plan is that it provides limited customization and has lower contribution limits.
If you are a business owner or employer planning to adopt a 401(k) plan, talk to a professional plan provider who will guide you through the process and help you understand which plan is best suited based on your business goals.