As a business owner, you’re likely aware of the importance of having a 401(k) plan for your employees. It can help attract and retain talent, provide tax advantages, and increase your bottom line. But there are some rules to be aware of when setting up and managing such plans.
From understanding eligibility requirements to knowing how much employers can match in contributions, these tips will ensure your business stays compliant when it comes to 401(k)s.
10 401(K) Rules That All Businesses Should Know About
401(k) plans are complex, and there are a lot of rules to follow. Don’t worry; we have you covered. In this article, we’ll share 10 must-know rules related to 401(k) plans for businesses.
1. Understand Qualified Plan Options
Employers must select a qualified plan provider to offer the 401(k). The provider must be registered with the IRS and follow their regulations for administering the plan. Financial experts would suggest that employees choose funds with annual expense ratios of 0.10%-0.30%.
Some other features of a great 401(k) plan include a generous match, immediate eligibility, immediate investing, low-cost investment options, catch-up contributions, and automation.
2. Understand 401(k) Compliance Regulations
It’s critical that business owners ensure compliance with applicable laws and regulations regarding 401(k) plans. Failure to do so can result in serious consequences, including hefty fines and penalties. As such, it’s essential to stay up-to-date on the most current regulations.
One thing to pay attention to is nondiscrimination testing, which requires key employees to stay within a specific contribution rate determined by the NHCEs. By understanding safe harbor 401(k) requirements, you may be able to be exempt from nondiscrimination testing.
3. Understand Eligibility Requirements
Employees must meet certain eligibility requirements in order to participate in a 401(k). Generally, this includes being at least 21 years old or employed by the company for one year (depending on your state’s laws). A traditional 401(k) plan may require 2 years of service.
An employee can not be excluded from a program if they reach old age. Leased employees are treated as full employees if they’re providing services for certain plan qualification rules.
4. Understand Contribution Maximums
Employees can contribute up to $20,500 to their 401(k) plan for 2022 and $22,500 for 2023. If the employee is over 50, they are eligible for an additional catch-up contribution of $6,500 for 2022 and $7,500 for 2023. This amount is subject to change each year based on inflation.
It’s also important to know that there’s a limit on the total contribution given by both the employer and employee. In 2022, that ceiling was $61,000 (or $67,500 with a catch-up contribution). In 2023, it’s $66,000 (or $73,500 with the catch-up contribution) instead.
5. Understand Employer Contribution Limits
Employers may match employee contributions, though this is not required by law. Employers may choose any matching percentage they deem appropriate for their situation or budget constraints. However, the typical contribution ranged from 50% up to 6% of a person’s salary.
Based on 2022 and 2023 contribution limits, the employee could contribute a max of $20,500 or $22,500, whereas an employer could contribute $40,500 or $43,500, respectively. This would bring the employee up to their contribution limits for both years, but this practice isn’t common.
6. Understand 401(k) Tax Implications
Contributions made by employees are pre-tax, and contributions made by employers are tax-deductible, as a rule. Employees won’t have to pay taxes on their retirement savings until they take their funds out. Employers can deduct most of their contributions from their taxes.
If you’re hiring a freelancer or a contractor and choose to give them a 401(k), note that there’s a possibility for both people to deduct their contributions from their taxes, so look into that.
7. Understand the Right to Knowledge
Employers must provide certain notices to employees informing them of the terms of the plan. This includes details on how much they can contribute and how their earnings will be taxed when they withdraw funds during retirement. All employees should know what they’re in for.
Employees should also have the right to opt out of a retirement savings account. Some employees may prefer to contribute to their own 401(k) and leave their boss out of it.
8. Understand When Funds are Accessible
Employees are generally not able to access penalty-free 401(k) funds until they reach age 59½ unless there is a specified hardship or other exception. There are also mandatory withdrawals after age 72. Penalties for early withdrawals are steep, so it isn’t worth it in most cases.
It’s important to tell employees what the exceptions are for penalty-free withdrawals. For example, an employee can take out their funds without a penalty if they need to pay for healthcare or a family emergency. Many exceptions are made for education or insurance.
9. Understanding 401(k) Loans and Borrowing
Employees may be able to take out loans from their accounts, but this option is usually only offered by larger plans. It’s important to understand the repayment terms before taking out such a loan, as non-repayment could be considered a taxable distribution from the account.
401(k) loans can be borrowed using a flat amount like $50,000 or 50% of the employee’s account balance. Keep in mind that they aren’t true loans because they don’t involve a lender.
10. Understanding What Happens When Employees Leave
If an employee leaves your company for any reason, you must follow specific rules for distributing their 401(k) funds in a timely manner (generally within 90 days). These rules vary based on state law and other factors, so it’s crucial that you consult with your provider first.
In most cases, the employee can take their 401(k) account with them, and employers can take back their contributions. However, it’s ill-advised to take back any contributions made, as that could negatively affect your business’s reputation, keeping talented employees away.