Ep #029: Investing for Retirement as a Business Owner Who Has Employees: The Traditional 401k vs Safe Harbor 401k
Did you know that 34% of entrepreneurs have no retirement savings plan for themselves? And many do not provide retirement benefits to their employees. So we kick off this episode by discussing common misconceptions preventing owners from setting up a plan for themselves and their employees.
We discuss common myths around setting up a 401k plan, explore the pros and cons of the Traditional 401k vs Safe Harbor 401k, and provide insights into which strategy may best suit your business.
LISTEN TO THE FULL EPISODE:
WHAT YOU’LL LEARN:
- Common misconceptions that prevent owners from setting up a 401k plan
- The pros and cons of the Traditional 401k vs Safe Harbor 401k
- How much to save and invest in a 401k plan
- How to set up and automate a "set it and forget it" savings strategy
- Who is the Third Party Administrator and what do they do
- How to Operate a 401k Plan
- What is the Retirement Plan Startup Cost Tax Credit?
- Small Business Retirement - Investing in Your Future
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- Introduction and Common 401k Myths
- The characteristics of the Traditional 401k vs Safe Harbor 401k
- What is a Traditional 401k?
- What is a Safe Harbor 401k?
- What is a third-party administrator (TPA) and how can they help business owners?
- How to contribute to your 401k plan
- What is a profit-sharing plan?
Introduction and Common 401k Myths
"Hey everybody we’re back with another episode discussing different retirement plans for business owners. Today we are diving into the Traditional 401k and Safe Harbor 401k. We will talk about the benefits of setting one of these up in your business, the differences between the two, and pros and cons of each."
"But before we do I want to address and cover several common misconceptions about the 401k that I’ve seen and that are known to prevent a business owner from setting one up."
"The first myth is “my business is too small to access a plan.” 64% of small business owners that don’t offer a plan indicate this is the reason. When the facts are, any size business can have a plan, even if you are self-employed with no employees."
"The second myth is “I can’t afford to offer a company match.” 18% indicate this is stopping them from offering a 401k plan. The fact is, matching isn’t required when you offer a 401k plan but if you do offer a match, it's tax-deductible to the business."
"The third myth is “it’s too expensive to set up and manage.” 14% of owners believe it’s too expensive. There are low-cost providers out there focused on the small business owner market where plans start as low as $100 / month, the core costs are tax-deductible, and there are substantial tax credits to help with setting up their first plan."
"Fourth myth and I hear this one a lot is, employees are not interested in having one. 12% of owners feel their employees won’t want it. While the fact is 85% of employees will participate in a 401k plan. Now grant it there needs to be some education around this because I agree it is a challenge to get your employees to want to participate, it’s a challenge to get them to understand the importance of taking a portion of your paycheck and saving it for the long-term. That’s where the person helping you set up the plan comes in. So for myself when I’ve worked with businesses in the past putting the plans in, I held a lunch-in with the employees and talked about the importance of saving for the long term, the importance of compounding your investments over time, and how it can grow for your eventual retirement. I get it, there’s a learning curve that comes with getting your employees on board, but once they are on board, the participation rate goes up."
"The last myth is “I Don’t want to take on the risks and responsibilities of managing one. 12% mentioned this one. And the reality is you don’t have to go about it alone. Work with a Certified Financial Planner to determine the right plan for you and your business and then you’ll partner up with what’s called a TPA or third-party administrator that handles all of the compliance for the plan. They handle the filing requirements, they support you when you have a new hire and need to get them enrolled, and they are your back office support for the 401k."
The characteristics of the Traditional 401k vs Safe Harbor 401k
"So with all of that said I hope none of those reasons are holding you back from exploring this."
"Ok let’s dig into the Traditional 401k vs Safe Harbor 401k. These plans are for businesses that have employees. You cannot do a Solo 401k if you have employees unless you are just working with your spouse. So good to know here, if it’s just you and your spouse running a small business, you can do a Solo 401k. You can do a SEP IRA if you have employees, but I would in most circumstances advise against it for reasons I mention in the prior episode, and that’s episode 28, if you haven’t heard that one yet."
"There’s a little more of an administrative burden that comes with setting up a 401k compared to a SEP or solo 401k. There are more IRS requirements too but the benefits far outweigh what you actually have to do on an annual basis to maintain these plans."
"Setting up a 401k for your business is not only a great way to save for your financial future but there are also multiple other benefits that come along with it that I’d like to go through: And those include:
"Lowering your tax bill. Deferrals into a 401k are taken pre-tax meaning before the money hits your bank account, a percentage is taken from your paycheck, not taxed, and it’s put into the plan. So if you make $100,000 in earnings and you defer up to the max of $22,500 for the year into the 401k, you lowered the amount of money you’ll be taxed on by $22,500. Not a bad deal."
"Your business can also deduct the contributions on the company’s federal income tax return."
"Having a 401k benefits your employees and encourages them to start saving for their own financial future. Education will most likely be needed here but once you have your team on board, It can also help with employee retention and reduce turnover."
"It’s also a great way to stay competitive in the marketplace for talent. One of the big factors in attracting high-quality candidates is compensation and benefits. Having a 401k plan with an attractive matching component can help your business stand out."
"The last one I’ll mention is your savings is automated. Which is so important. Meaning once everything is set up with the plan, you pick your investment, and you choose how much you want to be deducted from your paycheck. It’s essentially sent to auto-pilot unless you want or need to change something. So you don’t have to continuously log in and manually move money. It’s a phenomenal set-it-and-forget approach."
"Ok so there are a ton of benefits for businesses on why they should do this but now how do we set one up? What are the options and differences between the Traditional 401k and Safe Harbor 401k? These two plans sound like the same thing but there are some key differences I’d like you all to know so when you do explore setting up a plan, you’ll be ahead of the game."
What is a Traditional 401k?
"So let’s start with the Traditional 401k."
"The traditional 401k is like a cafeteria plan, meaning you can have a lot of options to pick and choose on how you want to set it up. You can create the matching schedule, you can make the vesting schedule, meaning you can decide how long does an employee have to stay with the company in order to be 100% fully vested and retain that match you give them. You can change how much the employee needs to contribute in order to get the match. So you have maximum flexibility, BUT with that comes more responsibility. With that comes more government rules you’ll need to follow."
What is a Safe Harbor 401k?
"When with the Safe Harbor 401k, that’s a plan that already has pre-approved limits by the IRS."
"When you go outside the pre-approved safe harbor limits, you are held to a higher standard of compliance. And what that means is the IRS starts looking at your plan in regards to how fair it is to your employees vs the Employer. They call this Annual Testing. And what that means is they look at how much you are contributing vs your employees, they compare balances, and there’s a rule of thumb that they go by. It’s the government verifying that the 401k is to the benefit of everyone working in your business."
"Safe Harbor 401k plans are pre-approved and already have set matching and vesting schedules so there’s less scrutiny by the IRS and the administrative burden is much easier to deal with. I like these plans a lot because it simplifies the process. And let’s be honest the last thing we want is another item on our to-do list to deal with on top of running our business."
What is a third-party administrator (TPA) and how can they help business owners?
"In addition regardless of which plan you choose whether you have employees or not, The good news is you don’t have to figure this all out on your own. In addition to your Certified Financial Planner, another key player that helps you set up these plans is the TPA, or Third Party Administrator. And the Third Party Administrator works to ensure your company’s plan complies with all the legal requirements. They take care of things like document preparation, benefit statement generation, and preparing for any testing requirements. I have a couple TPAs that I have used in the past setting up plans in business’ and their job is to relieve the administrative burden off of you, the business owner. Once the plan is set up, then it’s just a matter of communicating the benefit to your employees and explaining to them the benefits of contributing and saving for their own retirement."
How to contribute to your 401k plan
"Now in the Traditional or Safe Harbor 401k, there are Employee Deferrals and Employer Contributions. So there are two ways money can go into your account. For you as the owner, you will have an employee deferral amount and then you can contribute as the ER. You can defer up to $22,500 into the plan and if you are over the age of 50, you can add an additional $7,500 for a total of $30,000 that goes into the plan as an EMPLOYEE deferral. Then on top of that the plan can have a matching component which adds more money into the plan as an Employer Contribution."
What is a profit-sharing plan?
"On top of that, there is another layer you can add on to contribute even more money, and that is by adding on a Profit Sharing component to the 401k."
"Very simply this is an option that allows businesses to add additional money into the plan for themselves and for their employees when they have a really good year. I love seeing these because it’s a phenomenal way to reward your employees, keep good retention, and incentivize them to work with you on growing the business. This is how you contribute up to the maximum amount per year into a plan, of which the cap is $66,000 for 2023. That’s a lot of money to save for retirement if you wanted to be aggressive."
"So for those of you that don’t have a plan set up, do your research, and explore what would work for you and your business. I understand we business owners want to pour every last dollar back into our business, and I don’t disagree, but to some point, having a portion of our money that is separate, that is being invested and meant to grow over the long term, is a smart way to diversify our wealth and manage risk. I will include links to resources in the show notes, and until next time make it a great day."