Why a traditional 401(k) is the best retirement plan for most small businesses | Expert Opinion

Every employer knows that offering benefits such as health insurance and vacation is important for attracting and retaining workers. But, just as important is offering a good retirement plan.

As many as 60% of employees ranked a retirement savings plan among their top three most important perks, according to a recent survey from payroll company ADP. Recent surveys from Goldman Sachs and employee benefits firm PeopleKeep reported similar findings.

“Retirement plans are an important savings vehicle for long-term savings,” said Christopher Dall, who works in retirement solutions at PNC Bank in Philadelphia. “It has become almost a moral imperative that these vehicles are available to employees.”

Offering a good retirement plan “is a powerful retention and recruiting tool,” said Shikha Mittra, president of Retire Smart Consulting in Princeton. “You’re not going to get the best talent if a prospective employee isn’t offered a retirement plan option,” she says.

But, for employers, choosing a good retirement plan can be complicated. There are simple and SEP (Simplified Employee Pension) individual retirement accounts, which are designed for very small businesses and allow employee contributions and employer matching. But these plans are limited.

A traditional 401(k) plan potentially comes with higher costs, administration, compliance, and fiduciary responsibilities. But still, experts like Dall and Mittra agree the 401(k) is the best choice of retirement plans for most businesses, especially those that plan on growth.

Why? Because these plans offer more flexibility, higher savings potential, and better long-term outcomes for both owners and employees.

With a traditional 401(k), employees can put away up to $24,500 for retirement this year by deducting their contributions from their “pretax” earnings. By doing this, they lower their taxable income while putting money away for the future. Employers can match these amounts up to a total of $72,000 combined. Workers over the age of 50 can make additional “catch-up” contributions with the same benefits.

These savings amounts are higher than what people can save with an IRA. And, according to Mittra, they can be more affordable and flexible because 401(k) contributions can also be in the form of profit sharing or discretionary contributions, which are not allowed by IRAs.

“Other retirement plans are less flexible than a 401(k),” she said. “Even if an employer doesn’t have the means to spend on a yearly basis, there are options.”

The 2022 SECURE 2.0 Act also allows employers to match their worker’s student loan payments with contributions to their plan and expands the definition of part-time employees who can participate. The Act now provides tax credits to offset plan start-up costs. For eligible businesses, Dall and Mittra said, the government can offset some matching contributions with tax credits.

In discussing 401(k) plans, “One of the biggest fears that we hear cited is the cost,” said Dall. “And what SECURE 2.0 did is essentially create credits or increase existing credits” for companies offering these plans.

The SECURE Act now allows even small employers to “pool” their retirement plan assets with other companies in order to save administrative fees and reduce their fiduciary obligations.

For additional savings, the 2022 SECURE Act also made it legal for employers to offer a Roth 401(k) savings option alongside a traditional plan. This allows eligible employers and employees to contribute after-tax income that grows tax free and has no distribution requirements (for traditional 401(k) plans, workers over the age of 73 must take minimum, taxable distributions from their plans).

Dall says business owners must remember that the more your employees contribute to a traditional 401(k) plan, the more you can contribute without failing discrimination rules. Such rules restrict contributions for higher paid executives and owners.

“Retirement plans can’t be set up in a way that favors the highly compensated employees within a given workforce at the cost of not sufficiently helping the non-highly compensated employees,” Dall said. “If employees don’t save enough, it limits the effectiveness for that highly compensated employee.”

Given the incentives for savings, the attractiveness to workers, and the credits available to offset costs, one would think that offering a retirement plan is a no-brainer for most employers. And yet, almost half of U.S. workers in the private sector still lack access to these plans, Pew Charitable Trusts reports.

The good news is that a number of financial institutions and wealth management firms can help you set up a 401(k) plan for your business.