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Employers are having a harder time hiring qualified personnel because of the lowest unemployment numbers our country has seen in decades. There is an official labor shortage in the United States for skilled labor. This environment empowers workers and allows them to pursue better benefits, higher wages, and more favorable working conditions.
Wes Shannon
Small businesses find themselves competing with large companies. One of the simplest employee benefits a small company can offer, and now one of the least expensive, is a 401(k) retirement plan.
Congress has made starting a 401(k) plan more affordable now by giving tax credits to companies with 50 or fewer employees. The tax credits can cover 100% of the costs for setting up a plan and additional tax credits are earned for employer contributions up to $1,000 per employee. For companies with fewer than 50 employees the startup cost can run $1,500 to $2,500 dollars depending on the services provided, but it can all be repaid via the tax credits.
A 401(k) plan is a defined contribution plan, which means that the employee assumes the risks of having an adequate retirement because the employee is the primary contributor. The more the employee contributes (that is, saves) the greater the balance at retirement. Matching contributions provided by the employer is a major incentive for employees to participate in the plan.
Owners of a business are normally limited to how much they can put into the plan for themselves because there are rules against discrimination against lower paid employees. The general rule of thumb is the owner’s contribution as a percentage of the owner’s pay cannot exceed more than 2% above the average contributions of all of the “non-highly compensated” employees.
For example: There are 10 employees making under $155,000 per year and only six of the 10 are contributing 5% of their pay to the plan. The average contribution of those 10 employees is 3% (5% times 6 equals 30%, divided by the total of 10 equals 3%). So now the owner cannot contribute an amount more than 5% of his or her pay (the average of the employees plus 2%). Therefore, a matching contribution by the employer gives an incentive for the employees to contribute more and thus allows the employer to contribute more.
Fortunately, the law provides an exception to this nondiscriminatory rule. The exception is called a “Safe Harbor” plan. If the employer will agree at the beginning of the year to either 1) contribute a flat 3% of payroll to the plan for all employees, or 2) match an employee’s contribution up to 4% of pay, then the discriminatory rule is waived, and the employer and all the highly compensated employees may contribute to the maximum contribution allowed. In 2024 the maximum is $23,500 annually plus an additional “catch-up” amount of $7,000 for persons over the age of 50.
Most 401(k) plans will allow a profit-sharing contribution to be made by the employer to the plan for all employees. This profit-sharing contribution can be integrated with Social Security benefits and “age weighted” to allow a higher percentage of the profit-sharing contribution to go to the higher paid and older employees. One of my clients who owns a small business is in his mid-60s and has five employees who make much less than he does. His employees are also all under the age of 40. Because of the higher income he has and his age being older when he contributes $60,000 to his profit-sharing plan about 94% of it goes to his account.
Using the profit-sharing component of a 401(k) plan and the “Safe Harbor” rules can allow a small business owner to provide a vehicle to his or her employees to make a nice retirement for them and a way to transfer money from the business to the owners’ personal account in a tax favorable manner.
If your company hasn’t started a 401(k) plan this is the time to consider doing so. The benefits are:
- Increasing employee retention
- Provides a vehicle for employees to create a comfortable retirement
- Allows the owner to build a retirement outside of the business
Contact your financial advisor and talk with him or her to see how to get a plan started. If you don’t have a financial adviser for your business I suggest you find a “fee-only” Registered Investment Advisor who has the Certified Financial Planner® certification.
Wes Shannon CFP® is a Certified Financial Planning Professional for Brazos Wealth Advisors.