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Grow Your Business Finances

401(k) Plan: What It Is and How to Choose One

401(k) Plan: What It Is and How to Choose One Credit: Style TTT/Shutterstock

When it comes to retirement savings, one of the most common and widely used plans is the 401(k). A 401(k) is part of a profit-sharing plan that allows employees to contribute a portion of their wages to individual accounts to save money for retirement. The money is deducted from their paycheck and deposited directly into their 401(k) account. With the exception of a Roth 401(k), these plans are tax-deferred, which means federal or state taxes aren't paid on earnings until the money is withdrawn.

Because the contributions don't count toward the employee's taxable income, the Internal Revenue Service sets limits on how much employees can contribute to a 401(k) plan each year. The limit for 2016 is $18,000, but can be adjusted in the future depending on cost of living.

Employers have the option to match, or make their own contributions to their employees' 401(k) plans as an enticement for them to participate. The amount will vary with each company, but the company may offer to match between 25 and 100 percent, up to a certain percentage of the employee's salary. The eligibility to participate also differs with each company, with some allowing employees to start contributing to a plan as soon as they are hired, and others requiring a waiting period of one month to a year.

Since the retirement industry forecasts changes years in advance, the trends in employer contribution and matching to employees' 401(k) plans should not change in the immediate future, said Andrew Meadows, vice president of brand and culture at Ubiquity Retirement + Savings. He does add, however, that there are upcoming state mandates for small business retirement plans, such as payroll-deduction IRAs. [See Related Story: Employee Retirement Plans: A Buyer's Guide]

A complete breakdown of 401(k) plans can be found on the IRS website, but the four most common types are:

  1. Traditional 401(k) plan. This is considered the most flexible of the plans and allows employees to make pretax contributions through payroll deductions.
  2. Safe Harbor 401(k) plan. This plan is similar to the traditional plan, except it mandates that employer contributions be vested as soon as they are made.
  3. Simple 401(k) plan. This plan can be offered only by businesses with fewer than 100 employees.
  4. Roth 401(k) plan. This plan is funded with post-tax income, so money saved  is not subject to any federal or state taxes as long as the investor reaches the age of 59 and a half before withdrawal.

You may think your business is too small for a 401(k) plan, but these plans aren't only for big companies. Meadows noted that this is a common misconception, and said small business owners have a few main reasons for being hesitant about implementing a 401(k):

  • Having a 401(k) plan would affect the success of the business if they already don't have enough money to run the business.
  • The plans are really complicated and usually involve a lot of jargon.
  • It is expensive. There are fees involved such as managing fees and investment fees that aren't usually presented at first.

While the IRS website tells you exactly what you need to know about the plans, your employees might not have any idea what it actually means. Meadows advised employers to "talk in regular words [and] take the complication out of it" when explaining the plan to your employees.

Don't understand the plan yourself, or have questions about your contributions as an employer? Consider hiring a financial adviser with plenty of experience in the industry, Meadows said.

"The best financial advisers are the people who have already done it," he added.

Want to consider some other options for retirement savings plans? Visit Business News Daily's guide.

Jennifer Post
Jennifer Post

Jennifer Post graduated from Rowan University in 2012 with a Bachelor's Degree in Journalism. Having worked in the food industry, print and online journalism, and marketing, she is now a freelance contributor for Business News Daily. When she's not working, you will find her exploring her current town of Cape May, NJ or binge watching Pretty Little Liars for the 700th time.