You’ve heard the term 401(k) or Roth 401(k) and you know it’s a great way to save for retirement. But how do you open a 401(k)? Are you able to start one on your own, or does an employer have to start one for you? There are many questions surrounding retirement savings. In this blog, we will answer five questions we often get asked about how to open a 401(k).
Why should I open a 401(k) account?
Let’s start with this major question. What’s the purpose of a 401(k) and why should we open one? 401(k) plans are a great way to save for retirement because of the tax advantages. They have higher contribution limits than an Individual Retirement Account (IRA), and they don’t have income limits like IRAs have. Often, 401(k) plans offer a Roth option, which allows you to grow your retirement savings tax-free regardless of your income.
There are so many benefits to 401(k) accounts. If you have access to one or can open one, it is a great tool to use! Read here for 8 401(k) benefits you might not know about to learn more about the many benefits 401(k) plans offer.
How do I open a 401(k)?
You can follow the steps below to open a 401(k) through your employer.
- Find out if you are eligible: 401(k) plans are typically offered by employers. Check with the HR department to see if you are eligible to participate. Some employers automatically enroll new employees in the workplace plan. Due to Secure Act 2.0, all employers will be required to do this starting in 2025.
- Enroll in the plan: If you are eligible, your employer will provide you with the necessary paperwork to enroll in the plan. You may want to find out if your employer does 401(k) matching. This will be an additional benefit of enrolling in a 401(k) plan. Some employers have specific enrollment periods or waiting periods before you can contribute to a 401(k) plan.
- Choose your investments: Most 401(k) plans offer a range of investment options. Some of these include mutual funds, index funds, and target-date funds. It is important to consider your risk tolerance and investment goals when selecting your investments.
- Choose how much you want to contribute and set up automatic contributions: Once you have enrolled in the plan and chosen your investments, you can decide how much you want to contribute. You should at least contribute enough money to get the employee match. A standard employer match is 50% or 100% of your contributions, up to a limit. This limit is often 3% to 6% of your salary.
Once you have decided on an amount then you can set up automatic contributions from your paycheck to your 401(k) account. By doing so, you can stay on track to achieve your financial goals. The 401(k) contribution limit for 2023 for individuals is $22,500, or $30,000 if you’re 50 or older.
What if I don’t have access to a 401(k)?
If you work for an employer that does not offer a 401(k), you do have other options for saving for retirement. Maxing out your Traditional IRA or Roth IRA each year is a great start. The maximum for 2023 is $6,500 per year, which is much lower than most people need to set aside to have a secure retirement. That doesn’t mean you have to stop saving. You can add money to a taxable brokerage account with the intention of saving those funds for retirement. This account won’t have the same tax-deferred (traditional) or tax-free (Roth) options that a retirement account has, but it can still be a solid way to save and invest for your future.
If your employer is open to a discussion about offering a 401(k) to their employees, bring it up. They may not know how easy it can be. Many employers don’t know that the business can receive tax benefits for offering a 401(k) to employees. It can also be a great retention tool to keep great employees when the company offers employee benefits. There are many reasons a company might want to consider starting a plan, and the employer may just need some information and a nudge to get the ball rolling.
Can I set up a 401(k) without an employer?
If you are self-employed or own a business with no employees except for your spouse, you can open a solo 401(k). A solo 401(k) is sometimes referred to as a self-employed 401(k). If you are a sole proprietor, working as a freelancer or a consultant, you may be able to set up a SEP IRA for yourself. However, if you don’t meet any of these criteria, then you can only access a 401(k) through an employer-sponsored plan.
Can I open a 401(k) on my own?
A 401(k) is offered by your employer so you generally cannot open a 401(k) on your own. If you are self-employed, then you may be able to open a 401(k) plan for yourself, called a Solo or single-participant 401(k) plan. You can open a solo 401(k) on your own with the help of a solo 401(k) provider. If your business is made up of only you or your spouse, these plans can be a great way to save for your retirement, and they are simple to set up! You can contribute for both yourself as the employee, and as the employer, so your contribution limits are higher than if you work for someone else. Read here for more information on Solo 401(k) plans.
How to open a 401(k) without an employer
While you cannot open a 401(k) without an employer, you can avail of other tax-advantaged retirement plans without an employer. This includes opening a solo 401(k), a traditional IRA, or a Roth IRA.
- Open a solo 401(k): If you are self-employed and have no W2 employees, then this may be a good option for you. For a solo 401(k) you are both the employee and the employer which means that you can put more into the 401(k).
- Open a traditional IRA: If you are not offered a 401(k) through your employer, then a traditional IRA may be an option for you. A traditional IRA allows individuals to save for retirement with tax-deferred growth. It also has more investment options compared to 401(k) plans. Depending on your income, you may be able to deduct your traditional IRA contributions from your tax return.
- Open a Roth IRA: This may be a good option for you if you are younger and have the time to benefit from compound interest. A traditional IRA and Roth IRA have the same contribution limits but they are taxed differently. You cannot deduct your Roth IRA contributions from your tax return, but your Roth IRA will grow tax-free.
It is best to talk to a credentialed, financial advisor about these options to find the best one for you and your employment situation.
Can small businesses offer a 401(k) plan?
Small businesses have previously shied away from offering 401(k) plans for financial reasons. For years, 401(k)s were priced for companies with many employees and were thus cost-prohibitive for small businesses. But now there are many affordable options available for small businesses. By offering a 401(k) plan as part of an employee compensation plan, small businesses can attract talented employees. There are some fees associated with setting up a 401(k) for your company, so it’s best to talk to 401(k) providers about the plan that will best suit your company.
How much does it take to open a 401(k)?
When you start a 401(k) plan for your company, there might be a one-time setup fee. This fee will cover things such as setting up the plan and educating the company employees about the 401(k) plan. In addition, there will likely be a monthly fee based on the number of participants and the amount of assets in the plan. The cost of the fee will depend on which 401(k) provider you choose.
How can I start a 401(k) for my business?
To open a 401(k), you need to find a 401(k) provider to work with. There are many options here, so you will want to know what your needs are before deciding. Here are a few things to keep in mind when looking for a plan provider:
Transparent fees: What will it cost you to use the service they are providing? What does this include? All of this should be transparent and clear when you are speaking with a plan provider. If they seem to be skirting the discussion of fees, it may be time to cross them off the list of potential providers. Compare their fees and services with other providers as well, lower fees don’t always mean they are the better option.
Services offered: As an employer offering a 401(k) plan, you become the plan fiduciary. This means you are upheld to the fiduciary standard, making decisions in the best interest of the plan participants (your employees) at all times. This can be daunting for some employers who are not familiar with managing 401(k) plans. Know your limits, and then find a plan provider who can help you.
Many providers will offer full services and share the fiduciary responsibility with you, but this comes at a cost. Find out what services you need by interviewing the providers and finding out what they offer. Then choose the one that best fits your needs and your budget.
Investment Options: Make sure that the 401(k) vendor has a good lineup of low-cost investment options for you and your employees to choose from. These will be the options the plan participants can choose from to grow their assets for retirement. Having a good selection at a low cost should not be overlooked.
How to set up 401(k) for a small business?
- Research retirement options for your business: Make sure that you talk to various 401(k) providers and decide which 401(k) plan you want to offer to your employees. Look closely at both the 401(k) provider fees and the fees of the investment funds available.
- Create a 401(k) plan document: This document must outline the details of the retirement plan and must comply with the IRS code. This can usually be done by your 401(k) provider or a third party administrator.
- Set up a trust: A plan’s assets must be held in a trust. You must select a trustee to handle the plan’s activities such as contributions. 401(k) providers will usually assign the trustees.
- Provide all of the 401(k) plan information to your employees: You must provide information such as the plan’s benefits, rights, and features. The 401(k) provider may also provide you with some information to help educate your employees about the retirement savings plan.
Companies do not have to offer a 401(k) but it can be a cost-effective way to compete for talented people in the workforce. Around 51% of employers who offer a 401(k) also offer matching contributions. Companies generally choose a 50% match on 401(k) contributions on up to 6% of the employees’ pay. If you are doing a safe harbor 401(k), you’ll need to choose a specific employer matching scheme.
What does safe harbor 401(k) mean?
A safe harbor 401(k) is a type of 401(k) that avoids the complicated annual nondiscrimination test requirements. Without a safe harbor 401(k), the employer needs to do a test each year on whether highly-compensated employees or owners are benefiting unequally from the 401(k) plan. If so, the company needs to give back those “excess” contributions to the employee. A safe harbor 401(k) is exempt from those tests.
To have a safe harbor 401(k), the plan must:
- Allow all employees to contribute up to the maximum allowed by the IRS,
- Provide mandatory contributions by the employer, either by giving an automatic 3% contribution for all workers, or matching 100% of up to 3% of an employee’s contribution and then 50% of a worker’s additional contributions, up to 5%. These employer contributions must vest immediately.
Do I have to offer 401(k) to all employees?
You can exclude certain groups of employees from participating in the 401(k) plan. For example, some 401(k) plans require one year of service before the employee can participate in the plan. Others exclude part-time employees (who work less than 1,000 hours per year) and young workers (below age 21). The exclusion must be reasonable and must not violate the minimum age and service requirements under Internal Revenue Code Section (IRC Sec.) 410(a). If you’re offering a 401(k) plan to attract talented employees, then it may be advantageous to offer it to all of your employees.
Get advice from a financial planner about your 401(k) today!
Now that you know how easy it can be to open a 401(k) plan, put that plan into action! If you’re wondering how to take full advantage of your 401(k) or other retirement plans, or have other financial questions you need answered, schedule a FREE consultation with one of our financial advisors today.
Kayla Welte, AFC®, ChFC®, CFP®, has been helping clients maximize their finances since 2009. With a background in financial education & counseling, Kayla is passionate about helping people prioritize & reach their financial goals. Kayla is a Financial Planner at District Capital Management, a financial planning firm designed to help professionals in their 30s & 40s elevate their finances. Schedule a free discovery call.
