A guide to small business 401(k)s in 2023: The basics, the benefits and the updates
Thinking about offering a 401(k) plan at your small business? Whether you’re a startup with five employees or an established small business with 50 or more, you’re in the right place.
No matter where you’re at in the 401(k) learning process, things are changing in 2023.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act 2.0 was recently signed into law. Why should you care? It means important updates to how employers operate 401(k)s and how employees participate in them are coming — this year and beyond.
To keep you up to date, we’re providing an educational guide to 401(k)s in 2023, including new developments small business owners like you may find important.
From square one to expert, this article has something for everyone. Keep reading for a walk-through of:
If you’re a little fuzzy on the nuances of 401(k)s and the rules surrounding them, let’s change that.
What is a 401(k)?
First things first: What’s with the jumble of numbers and letters? The name “401(k)” actually comes from a section of the Internal Revenue tax code that permits employers to create a retirement plan for employees. What is that section called? You guessed it, Section 401(k).
Beyond the origin of its name, a 401(k) is a qualified retirement savings plan sponsored by an employer to help eligible employees save for retirement. It's also known as a defined contribution plan, which is a fancy way of saying both employees and employers (that’s you) can voluntarily make contributions.
How does it work?
It’s simpler than you might think. Employees elect to contribute a certain percentage of their earnings to their 401(k) via regular payroll deductions. And as an employer, you have the opportunity to make additional contributions or offer matching as well.
That’s great, but where does the money go from there? After money enters a 401(k), it’s invested in a portfolio of mutual funds, stocks and bonds chosen by the employee. Via those investments, their money has the potential to grow over time. Then, when they hit retirement or reach 59½ years old, they're free to withdraw their funds.
What types of 401(k) plans are there?
There are two main types of plans that have one key difference:
Traditional 401(k): Contributions are made with pre-tax dollars, meaning the money is not taxed until it’s withdrawn at retirement. (This is the one we’ll be focusing on for the majority of the article.)
Roth 401(k): Contributions are made with after-tax dollars, meaning the money is taxed before it goes into the account and won’t be taxed upon withdrawal.
While traditional and Roth are most likely the two you’ve heard about before, there are three more popular types of 401(k) plans worth noting.
Safe harbor 401(k): This one requires employers to make fully vested contributions to employees’ accounts. In return, they get safe harbor status. That means they’re exempt from the annual IRS nondiscrimination tests that apply to traditional and Roth 401(k)s — a series of tests that ensure all employees are treated equally under your plan.
SIMPLE 401(k): This is very similar to a safe harbor plan, but only businesses with 100 or fewer employees who were paid at least $5,000 the previous year are eligible.
Solo 401(k): To qualify for this plan, the only employees can be you and your spouse. It comes with all the benefits of a traditional plan but fewer compliance requirements — again, no nondiscrimination testing.
How do I make 401(k) contributions as an employer?
While it’s not required, you do have the option to make 401(k) contributions to your employees’ accounts in a few ways.
Matching: This is when you match what an employee contributes to their 401(k) up to a certain amount. You can do a dollar-for-dollar match where you put in the same amount as your employee. Or you can do a partial match by matching a certain percentage of what your employee contributes.
Looking for an example? The most common matching formula is 50 cents for each dollar contributed by the employee up to 6%. Through 2022, regardless of whether the employee selected a traditional or Roth account, as an employer your contribution would always go into a traditional 401(k), so your funds would not be taxable. However, this is changing in 2023. (We’ll get to that in a bit.)
Vesting: Another option is to establish a vesting schedule — a length of time (up to six years) that an employee must work for you before they can own your matches 100%.
Vesting can happen gradually. For example, 20% of your employer match belongs to the employee after one year, 40% after two years and so on. Or it can happen all at once after the waiting period has ended — going from 0% to 100%. The appeal of vesting? If an employee leaves before the vesting period is up, your employer contribution (or a percentage of it) could go back to you.
Profit sharing: Profit sharing, also known as a nonelective contribution, is an additional pre-tax contribution you can make to an employee's 401(k) account. How does that differ from matching? The employee doesn't have to elect to make their own salary deferrals into the plan in order to receive funds from their employer.
What’s the difference between a 401(k), IRA and pension?
Defined contribution plan
Individual retirement account
Defined benefit plan
Am I required to offer a 401(k)?
The short answer? No, 401(k)s are generally not mandatory.
The more complicated answer? In some states, if an employer does not offer a 401(k) or alternative qualifying retirement plan, they’re required by law to enroll their business in the state-sponsored retirement plan. Here’s a list of states that mandate retirement plans:
California: “Employers are required to participate in CalSavers if they employ an average of five or more employees and do not sponsor a retirement plan.”
Colorado: “All eligible Colorado employers are required by law to facilitate Colorado SecureSavings if they don’t offer a retirement plan for their employees.”
Connecticut: “Qualified employers with five or more employees in Connecticut — at least five of whom have been paid more than $5,000 in the calendar year — are required by law to join MyCTSavings if they don’t offer a retirement plan for their employees.”
Illinois: “State law now requires every Illinois employer with five or more employees to offer their own retirement program or facilitate Secure Choice.”
Maryland: “Under Maryland law, most* Maryland employers must soon offer their employees some sort of retirement savings. This can be a traditional pension, a 401(k) plan, a 403(b) plan, a SEP plan, a SIMPLE IRA plan, a governmental deferred compensation plan — or a WorkLife Account from MarylandSaves.”
Oregon: “All Oregon employers are required by law to facilitate OregonSaves if they don’t offer a retirement plan for their employees.”
Virginia: “Certain Virginia employers that don’t offer a qualified retirement savings plan are required by state law to facilitate the RetirePath program when it opens in 2023.”
On the horizon:
- Maine Retirement Savings Program
- New Jersey Secure Choice Savings Program
- New York State Secure Choice Savings Program
- Delaware Expanding Access for Retirement and Necessary Savings (EARNS)
- Hawaii Retirement Savings Program
If you don’t see your state listed above, still be sure to check — things are always changing! If you have questions, consult your legal counsel.
2023 updates from the SECURE Act 2.0
Now that we’ve covered the basics, it’s time to talk about what’s changing this year.
But first a little background: The original SECURE Act passed on December 20, 2019, and made big changes to retirement savings plans. But when the Consolidated Appropriations Act, aka the $1.7 trillion omnibus spending bill, was signed into law on December 29, 2022, it included new legislation for the SECURE Act. Hence the 2.0.
SECURE 2.0 is designed to promote retirement savings, encourage new plans and increase tax savings for small businesses. While this is not a comprehensive list (there are 90+ new retirement plan provisions!), below we’re covering some of the key changes you and your employees should know about if you plan to offer a 401(k) in 2023.
Startup tax credit doubled: If you didn’t already know, eligible businesses can receive a startup tax credit for setting up a new retirement plan. The big news? The credit is expanding from covering 50% of startup costs to 100%. (More on that later!)
Automatic enrollment to be required: If you set up a new retirement plan after December 29, 2022, you’ll be required to automatically enroll your employees into the 401(k) plan at a rate between 3% and 10% of pay — but not until 2025. Once 2025 hits, contributions must increase by 1% each year until at least 10% is reached, but not more than 15%.
Incentives to participate authorized: Worried employees won’t participate if you do go to the trouble of setting up a 401(k)? For plans established after December 2022, employers are now allowed to offer small financial incentives (think gift cards) to encourage employees to participate in their plan.
New student loan matching established: Looking to up your postgraduate recruiting game? Beginning in 2024, you’ll be able to make matching contributions when an employee makes a student loan payment, so they can pay off their debt while you help them save for retirement at the same time.
Requirements for part-time workers to be reduced: If you think your staff roster is too small to warrant a plan, it could apply to more than just your full-time employees. Starting in 2025, you can add part-time employees to your 401(k) plan who have worked at your business two consecutive years (and at least 500 hours) instead of the previously required three years.
For your employees
Catch-up contributions increased: If you have older employees on board, this one’s important. Catch-up contributions are a provision for people 50 or older to make additional 401(k) contributions beyond the standard limit. Starting in 2025, workers who are 60-63 will be allowed to make catch-up contributions up to $10,000 per year (or 50% more than the regular catch-up amount for 2024). For employees 50 or older, the catch-up contribution limit will also be indexed for inflation.
RMD age limits raised: Just as there’s an age limit for when employees can start withdrawing funds from their 401(k), there’s also an age limit by which they’re required to. This is known as required minimum distributions (RMD) — the annual amount plan participants must withdraw once they hit a certain age. Up until now, that age has been 72 years old. But SECURE 2.0 is raising it to 73 in 2023, then to 75 in 2033.
RMD penalties lowered: The penalty for failing to take RMDs will also change this year. The current 50% tax of the RMD amount that should have been withdrawn will drop down to 25%. That penalty lowers even more to 10% if the employee takes the RMD by two years after the due date.
Roth employer matching introduced: As of 2023, employees can choose to have their employer’s matches and nonelective contributions go into their Roth account instead of a separate traditional, pre-tax account. This allows employer after-tax contributions for the first time.
Emergency withdrawal penalties lowered: If you have employees below retirement age who fall on hard times, this is also a good one to know. Starting in 2024 the 10% penalty employees younger than 59 ½ face if they make an early emergency withdrawal from their 401(k) will be eliminated for withdrawals up to $1,000 annually.
Potential benefits of offering a 401(k)
Basics, check. Updates, check. Wondering what the benefits of 401(k)s are now? Let’s jump in.
Recruiting and retaining employees
With the ongoing labor shortage, you have a competitive hiring market to contend with. If a top-notch candidate is deciding between two positions, and one business offers a 401(k) plan while the other doesn't, the 401(k) could be the factor that tips the scales.
Just look at the numbers: According to a survey, 88% of employees said a 401(k) was a must-have benefit when looking for a job. Another survey revealed that retirement plans ranked as the most-wanted benefit after health insurance.
Despite the appetite for 401(k)s, the number of small businesses that actually offer them is quite low. According to one survey, out of 5.8 million small businesses, 90% did not offer a 401(k) and 74% of small businesses didn’t offer any kind of retirement plan.
All that to say, if you’re struggling to attract the numbers and caliber of talent you want, offering a 401(k) could give you the competitive edge you’ve been looking for.
Beyond bolstering recruitment efforts, offering a 401(k) plan also has the potential to help reduce employee turnover, resulting in less time and money spent on hiring and training.
Got all-star employees on your team who you could see becoming an integral part of your business' future? Don’t assume it's only a matter of time until those employees automatically leave for bigger-name companies. If you’re looking to retain your best and brightest, offering inclusive and attractive retirement benefits can help. A survey showed that 75% of new hires viewed a 401(k) plan as a compelling reason to stay at a job.
Think of it this way: If your employees have a way to save for retirement, they'll probably have an easier time envisioning a realistic future with your company. Plus, offering a 401(k) plan lets employees know you’re investing in them. And when that happens, they'll be more likely to invest right back into your business.
If you’re considering setting up a small business 401(k) plan, there’s more good news: They come with some serious tax incentives.
Startup credit: Thanks to SECURE 2.0, eligible small businesses with 50 employees or less implementing a first-time 401(k) plan get a startup credit equal to 100% of the plan’s administrative startup costs or up to $5,000 per year for the first three years they offer the plan. That's up to $15,000 total to help get your 401(k) on its feet.
One important note — the original SECURE Act offered businesses a tax credit equal to 50% of qualified startup costs, with the same $5,000 cap. If you’re a business with 51-100 employees, you’re still subject to this original amount.
Auto enrollment credit: On top of the startup credit, if you include an automatic enrollment feature as part of your new or existing 401(k) plan, you get an additional tax credit of $500 per year for the first three years the feature is active — totalling an extra $1,500.
Put it all together and what do you get? Tax credits that can total up to $5,500 per year and $16,500 for all three years.
The tax advantages don’t stop there. When you contribute to an employee's traditional 401(k) plan as an employer (via nonelective contributions or matching), those voluntary contributions are tax-deductible on your federal income tax return, ultimately driving down your business' tax liability.
However there are limits: For 2023, employee contributions are limited to $22,500, and the total contribution from both the employer and the employee to a 401(k) plan can't exceed the lesser of 100% of an employee's salary or $66,000. It's also worth noting that the 2023 catch-up contribution limit is $7,500 for participants over the age of 50. (So with catch-up, the total limit is $73,500.)
Be sure to keep these limits in mind when making your contributions, so you don’t run into trouble when tax season rolls around.
Take the complexity out of 401(k) plans with a full-service payroll solution
If you made it to the end of this guide and you’ve decided offering a 401(k) plan is right for your small business, getting one started may not be as complicated or costly as its reputation would have you believe.
While piles of paperwork and complex fine print might spring to mind at first, a 401(k) program can actually be quite simple to set up and manage — and the payroll provider you choose to work with has everything to do with it.
When selecting a service provider, it's a must-have for any modern small business to go with a solution that gives you the ability to seamlessly integrate your 401(k) system with your payroll platform.
That's why Heartland is committed to providing you with a powerful payroll solution that integrates all the hire-to-retire workforce management tools you need, including 401(k).
Our payroll solution eliminates friction, allowing you to smoothly exchange information with an extensive list of partners you can trust to manage your 401(k). Best of all, a team of payroll experts is just a call or email away whenever you need a helping hand.
Contact us today to learn more or talk to a specialist about getting your business’ 401(k) plan up and running.
Disclaimer: The information provided in this document does not, and is not intended to constitute legal advice; instead, all information, content, and materials available are for general informational purposes only. Information provided may not constitute the most up-to-date legal or other information, and readers of this information should contact their attorney to obtain advice with respect to any particular legal matter, in the relevant jurisdiction. All liability with respect to actions taken or not taken based on the contents here are hereby expressly disclaimed.
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