If you are a business owner, chances are you’ve wondered whether starting a retirement plan would be beneficial for you. Not only does it allow you to save more than a traditional IRA plan, it may increase employee loyalty and morale too. The thing is, the earlier you start in the calendar year, the better it is for everyone. Here are some reasons why January would be a great month to get started.
1. Nondiscrimination Testing is Predictable
Many business owners want to start 401(k) plans late in the year with the intention to save as much as they can to reduce their tax liability. The issue with this is that while they may be able to make those large contributions, many of their employees are not able to do the same. When you have a large discrepancy on contribution amounts among executives and regular employees, you may run into an issue with nondiscrimination testing.
We offer 401(k) education and enrollment meetings throughout the year along with the plan providers preliminary testing to ensure you don’t run into these issues. By being able to better predict the outcome, many compliance issues can be prevented.
2. Safe Harbor Plans Must Be in Place Before October 1st
If you have a small business with a handful of employees, a Safe Harbor plan is a smart decision as it allows you to avoid non-discrimination issues. For example, if your goal was to put away the max into a 401(k) plan but your employees decide to not participate or contribute very little, we run into the nondiscrimination testing issue again. A Safe Harbor plan ensures the plan is fair and equal to all with a minimum matching contribution made to employees accounts.
By starting in January, it’s a great benefit to offer for the full year with minimal compliance headaches.
3. Employees Have a Whole Year to Make Contributions
Typically, employees are able to defer 100% of their pay each pay period. If they don’t make at least $19,500 from the start of the year, they won’t have any chance of maxing out their 401(k) plan. As a business owner, while you may be able to max out your plan in a few months your employees have less time and income to do the same. Again, we run into the testing issues. Having more time will benefit all parties.
4. Employer Matching Contributions Will Be Limited
Many assume they can take advantage of matching contributions late in the year. This is not always accurate. Many 401(k) plans calculate matching on a pay-period basis. That means your matching contribution is based only on that pay period’s contribution and not the whole year.
For example, if you pay your employees monthly and start a plan October 1st that means there are 3 pay periods left in the year. If your employee makes $195,000 annually and elects to contribute 10% of their pay that means they would only contribute a total of $4,875 for the remainder of the year. ($195,000 / 12 pay periods = $16,250 monthly paycheck –> $16,250 x 10% = $1,625 –> $1,625 x 3 pay periods = $4,875)
This can be confusing for some employees if their intention was to max out their retirement plan for the year and take full advantage of the matching contribution. Again, by providing more time throughout the year, you and your employees are able to space out those contributions so there is no disruption in their normal cash flow needs.
There are many reasons why starting a plan early in the year makes sense. We can help you with all the details if a retirement benefit is something you’ve been considering in your business. Contact me at [email protected] or schedule an introductory meeting here.