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The Benefits of 401(k) Plans for Startups.

October 12, 2016

When a founder is launching a start-up, a retirement savings plan for the company is usually the last item on the “to do” list, if this task makes the list at all.

While many small business owners may consider offering a 401(k) plan, many decide against it based on uncertainty over costs, a cumbersome set-up process and the administrative burden that is required to run it.

As a result of these perceptual and real barriers, fewer than one in five small businesses in the US offer some type of retirement savings plan based on a study done by the US Government Accountability Office.

But the need to offer more tangible employee benefits in the highly competitive start-up labor market, coupled with technology-driven changes in the asset management sector have many start-ups thinking again about offering 401(k) retirement savings plans.

There are also some attractive tax implications that founders should consider when deciding if they want to set up a 401(k) plan.

THE OBVIOUS BENEFITS OF OFFERING A RETIREMENT SAVINGS PLAN.

With the explosive proliferation of start-up businesses in many parts of the country, the labor market has become extremely competitive. Many founders are finding it difficult, if not impossible to recruit high-value employees (like software developers) who can help build and scale start-up businesses. According to payscale.com iOS / Swift smartphone app developers earn an average of $79K per year, with compensation ranging up to $130K per year

Attracting Start Up Talent    

Offering a hip workplace, along with free lunch / snacks, is often not enough to attract and retain the best and brightest people today. Beyond straight cash compensation and stock options, founders might be wise to consider adding a very tangible benefit: A tax-qualified, defined contribution pension account or 401(k).

As the New York Times recently reported “Very few start-ups offer retirement plans on Day 1,” said Jamie Hopkins, a professor at the American College of Financial Services in Bryn Mawr, Pa., which trains financial professionals, and a co-director of its New York Life Center for Retirement Income. “Less than 10 percent of start-ups offer a plan.”

Under these plans retirement savings contributions are provided (and sometimes proportionally matched) by an employer, deducted from the employee’s paycheck before taxation (therefore tax-deferred until withdrawn after retirement or otherwise permitted by applicable law) and limited to a maximum pre-tax annual contribution of $18,000 per year as of 2016. Employees age 50 and older can contribute an additional $6,000 per year.

THE TAX BENEFITS OF OFFERING A 401(K) PLAN:

401(k) plans are designed to deliver some great tax advantages that can benefit founders in the year they are established, and well into the future. In fact, it may even cost a business less than not having one at all.

The tax breaks can include:

Start Up Tax Benefits    

  • $500 tax credit if it is the firm’s first 401(k) and you have employees to help cover the cost of establishing, administering or educating employees about a plan.
  • Matching contributions, profit sharing and administrative fees are deductible business expenses.
  • Founders themselves can contribute up $18,000 ($24,000 if they are age 50+) tax-deferred in 2016 plus any matching contribution they receive.

TECHNOLOGY CAN MAKE 401(k) PLANS MORE CONVENIENT, CHEAPER AND EASIER TO ADMINISTER.

An inexpensive retirement savings plan option is available through robo-advisers like NYC-based Betterment and ForUsAll. They run on auto-pilot, often cost just a fraction of a more traditional retirement savings program, and are typically available to smaller sized businesses.

Another retirement plan option for small employers that is gaining more attention is the Multiple Employer Plan (MEP). A MEP is a single 401(k) plan that allows two or more unrelated companies to participate.  Under this arrangement, a “SPONSOR”, such as TriNet handles the plan administration and assumes the majority of fiduciary liability.  By pooling the plan’s assets, the SPONSOR is able to obtain the best prices from providers.   For a small businesses, the MEP offers two advantages:  lower overall costs and offloading of the plan administration.

Such plans also generally offer better website interfaces and easy-to-understand advice, perfect for emerging growth company employees.

The Wall Street Journal recently reported on how these new online plans are disrupting the retirement savings market.

Betterment for Business

“The 401(k) market is ripe for disruption,” said Cynthia Loh, general manager of robo-advisory pioneer Betterment LLC’s 401(k) business. “Everybody is trying to leverage technology to make things more efficient.”

This approach will likely be music to the ears of many tech-enabled start-up founders – who are taking the same approach to their business models.

This material has been prepared for general informational and educational purposes only and is not intended, and should not be relied upon, as accounting, tax or other professional advice. Please refer to your advisors for specific advice.

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