Best 401k Design for Your Business

Solo 401(k)

401(k) Benefits for Businesses Without Employees

This type of plan lets the self-employed and owner-only businesses gain access to 401(k) benefits (learn how you can save up to $69,000 or more per year with a Solo 401(k) plan). Spouses can also be included.

If you don’t have employees and want 401(k) benefits, this is the way to go as long as you are committed to saving more than $7,000 per year. Otherwise an IRA is probably a better fit. Once you have employees, you will need to consider one of the three other plan designs below.

Safe Harbor 401(k) Plans

The Popular Choice

This plan type helps maximize savings and simplifies plan management for a business. Top things to know about Safe Harbor plans:

Enables owners and key employees to maximize their personal contributions by providing an immediately vesting match for all employees.
Automatically satisfies IRS non-discrimination testing.
Employer matching contributions are tax deductible for your business.

No matter the plan design, 401(k) plans are required to be run in the best interest of all employees. The IRS has nondiscrimination tests to help ensure that this is the case.

These tests require that plans can serve everyone at a company, and not just tilted to a few highly-compensated employees (employees who earn more than $155,000 a year, own more than a 5% stake in your company, or are in the top 20% of earners at your firm). If the bulk of employees are not contributing enough to the plan, highly-compensated employees will face restrictions on how much they are able to contribute. In some cases, that restriction will fall well below the $23,000 per year contribution limit. It’s common for leaders at a company to want to take advantage of maximizing their contributions. Moreover, satisfying IRS non-discrimination testing can be costly and time consuming for a business.

Luckily, Safe Harbor plans automatically satisfy the requirements of non-discrimination testing without all of the hassles. By providing a “Safe Harbor” immediately vesting, matching contribution to all employees (including the owner), employers guarantee that all employees will be able to contribute the maximum amount to their accounts if they choose. Most employers choose to either match 3% or 4% of salary.

Traditional 401(k) Plan

Customize to Your Business Needs

This plan design gives you more options to tailor for your needs. Top things to know about Traditional plans:

To match or not to match–employers decide whether to provide a match or not and offers more options on how to structure the match.
Allows employers to establish vesting and/or eligibility rules to retain and reward loyal associates.

Tip: Automatic enrollment is typically a good idea with any plan design but is often more essential with traditional plans to help the plan better meet IRS testing requirements. You’ll likely want to set this at 5% or more to ensure your plan passes plan tests. Note that for employers with 11 or more employees, automatic enrollment is a required feature of your plan (exception exists for plans established before 12/29/2022).

Traditional plans are a smart option for businesses who have highly seasonal cash flows, experience relatively high employee turnover, or need the flexibility to leverage a different match amount than a Safe Harbor would require. The ability to add in multi-year vesting schedules also makes these plans a valuable tool for employee retention and to help reduce costly turnover. In addition, eligibility rules can simplify administration and plan costs for businesses that have seasonal work forces.

As mentioned in the Safe Harbor section, the amount top employees can contribute can be restricted. Highly compensated employees can only contribute two percent more of their salary than the average percent of salary contributed by non-highly compensated employees. For example, if the average employee in a business contributes 4% of their salary, the owner and highly-compensated employees can contribute no more than 6% of their salaries. For owners and key employees, this percentage may fall well below the 401(k) contribution limit. By using automatic enrollment that enrolls your employees at 5% to 10%, you can help your plan more likely pass testing and enable more people to contribute the maximum.

Advanced Profit Sharing

Contribute Differently to Employees by Grouping

This 401(k) option allows you to:

Reward different groups of employees with different levels of profit sharing
Profit-sharing contributions into 401(k)s are tax deductible for your business
Can be used in conjunction with a Safe Harbor 401(k) to help ensure you satisfy plan tests

Profit sharing can be a component of any plan design. It’s quite simple to provide a profit share of the same percent or amount across all employees. A special type of profit sharing that can allow more options is known as Advanced Profit Sharing or Tiered Profit Sharing.

Advanced Profit Sharing allows employers to identify unique groups of employees within the company and reward employees a different percentage or amount of profits by group.

Employees are typically divided in one of two ways. The first is to divide employees into clearly different groups based on income, job role or other criteria of which compensation is a defining component. The other is an Age Weighted plan, which uses age as the primary factor for profit allocation. Regardless, of how employees are grouped, a different percent of salary can be provided as a profit share for each defined group.

Tiered Profit-Sharing plans can be viewed as a feature to add to a Safe Harbor or Traditional Plan design. It’s common to offer a Safe Harbor match to employees along with a Tiered Profit-Sharing plan in order to satisfy government requirements while still offering additional profit-sharing benefits to employees.

What 401(k) Plan Design is Best for Your Business?