We’re increasingly on our own when it comes to saving for retirement — whatever your version of retirement looks like. Previous generations enjoyed defined-benefit plans (or pensions) to support them when they stopped working. Now, most people with workplace benefits have defined-contribution plans like 401k plans. There’s also Social Security, but that’s not getting any more generous.
If you don’t have retirement accounts available, it’s time to start your own 401k or similar retirement savings program. The route you take will depend on your situation. You’re either:
- An employer, self-employed individual, or benefits manager who wants to set up a 401k plan for your business, or
- An employee of a company that does not currently offer a retirement plan
- About to sign up for your employer’s 401(k) and you want to learn how (if so, read this instead)
If number 2 applies (you’re an employee earning W-2 wages), you may not be able to set a plan up yourself, but you still options, which we’ll discuss below — scroll down to the green box with white text if you want. 401k plans are employer-sponsored retirement plans, so your employer must establish a plan unless you earn any self-employment income. If your employer won’t play along (they might just need some nudging), you need to take matters into your own hands.
How to Start a 401k
Setting up a 401k plan can be as simple or as complicated as you like. Most people outsource at least some portion of the process. In particular, they use a “template” legal document to establish the 401k plan, which is substantially less expensive than hiring attorneys to draft original documents. Unless your retirement plan is especially complicated or you’re trying to get fancy (and you’re willing to pay for extra features), you’ll probably use preconfigured programs from 401k vendors. These programs are often called “volume submitter” or prototype plans, and they’re an excellent choice for most companies and nonprofits.
Here are the crucial pieces of any 401k plan. While this list seems extensive, in some cases, a single company provides several of these services.
The plan document is a legal document that details the rules of your 401k plan. It explains the general rules of a 401k plan, defines specific terms, and provides a roadmap for any questions that come up when administering the plan. The plan document is a lengthy legal document that most people never see. Instead, employees receive a summarized version of the document, known as the Summary Plan Description (SPD), when they enroll in the plan. For reference, here’s a sample of a plan document.
The adoption agreement is a document you use to establish your 401k plan. The adoption agreement allows you to customize the plan so it fits your goals and your organization. In many cases, it’s a list with numerous checkboxes: Do you want to allow loans — yes or no? Is there a match? What kind? Which vesting schedule do you want to use? The plan document is more or less boilerplate required language for any plan, but the adoption agreement makes it your own plan.
The trust is a legal entity, and it’s what you might call the plan. Using a plan document and adoption agreement, your 401k service providers create the trust for you (it’s less complicated than it sounds). Every trust needs a trustee, so you must decide who will serve as trustee of your plan. In most cases, it’s the business owner, president, or somebody in a similar role. If you’re self-employed, you’ll most likely serve as the trustee of your own 401k plan. The trustee is the one legally responsible for ensuring that the plan follows all rules and laws, so it is somewhat risky to take on this role — especially if you run a large company. However, countless trustees around the nation serve without any problems.
Plan administrator: Somebody needs to administer the plan on a day-to-day basis. This person does not have the same level of responsibility as a trustee, but they need to be aware of important rules and deadlines. In many cases, the administrator and trustee are the same person. This is the Plan Administrator, and is not the same as the Third-Party Administrator.
Third-party administrators (TPAs): A TPA performs critical services for a 401k plan, such as filing tax returns for the plan, interpreting rules if there are questions, annual discrimination testing, and processing loan or distribution requests. A good TPA helps employers avoid mistakes, and these organizations are available both locally and nationwide. You might use a TPA as part of a bundled service with your recordkeeper or other vendors, or you can hire a firm that only does administration. Especially when you want to customize a plan, a separate TPA can be useful.
Recordkeepers or investment providers are probably who you think of as your 401k vendor. These are often large financial companies that you send contributions to. They print your statements and run the website you use to trade and invest. Depending on how you set up your plan, the investment provider and recordkeeper (as well as the TPA) might be the same company. This is often the arrangement for self-employed people setting up a Solo 401k. Numerous providers exist with varying levels of service and fee structures, and big names aren’t always best, especially for small plans.
Financial advisors and consultants are individuals or firms that provide advice to employers (and possibly employees or “participants”). For an additional fee, they’re available to help you decide what type of plan is best, how to set up the plan, which investments might be appropriate for the menu (if applicable), and which individual investments to choose within the plan. Some investment advisers, like 3(38) fiduciaries, manage funds and make changes in participant accounts with no involvement from employees, while others provide advice and you implement the changes yourself. TPAs and recordkeepers also provide some level of consulting, and they may be able to provide insight into several areas above.
How to Set up a 401k Plan
Now that you know the landscape, you’re ready to set up a plan as an employer or self-employed individual. Whether you’re establishing a plan for a large enterprise or or on your own the next steps are:
- If you’re self employed, decide if you want a SoloK, SEP, or SIMPLE,
- Decide if you want to use a financial advisor or other consultants.
- Decide which plan provisions you want (loans, Roth 401k, Safe Harbor, matching?).
- Choose a vendor (evaluate flat-rate pricing, investment costs and fees, technology, and other features).
- Complete the adoption agreement along with other agreements and submit to your vendor(s).
- Communicate and educate: Inform employees (if any) of the plan’s existence and features.
- Set up individual participant accounts.
- Fund the plan through payroll or any employer contributions.
- Review the plan regularly to ensure it’s meeting the needs of plan participants.
- Monitor and adjust the plan as regulations change and your needs evolve.
- Provide required information to participants on an ongoing basis.
Start Your Own Retirement Plan (When Your Employer Doesn’t)
When you’re an employee, you can only use a 401k plan if your employer establishes a plan and you’re eligible to contribute. All too often, that’s not the case. But you still have options.
Ask for a 401k: Your employer might be willing to set up a 401k — they just haven’t done it yet. Start the conversation by asking why there isn’t one, why you want one, and that there are potential tax (and other) benefits for employers. Explain that valuable employees like yourself would be even more valuable with excellent benefits. Offer to do some (or all) of the legwork required to get the plan up and running. In some cases, especially with small organizations, your employer simply doesn’t have time to set up a plan. Cost is another factor — companies and small nonprofits might be hesitant to pay plan costs (not to mention matching, profit sharing, or required contributions to employees). If cost is the primary concern, discuss less-expensive options like SIMPLE plans. Only time will tell if it’ll actually happen, but it never hurts to ask.
IRAs: If you don’t have a 401k, you may still be able to save in an individual retirement account (IRA), and you might even receive tax benefits similar to a 401k. Unfortunately, the IRS sets maximum annual limits much lower for IRAs. Still, something is better than nothing. Evaluate traditional IRAs for potential pre-tax saving, and Roth IRAs for possible tax-free withdrawals (assuming you follow all IRS rules). Another drawback of IRAs (compared to a 401k) is that you may need to qualify to make contributions or receive a deduction. Speak with a tax expert before you do anything.
Side job? Put it all away. If you have any self-employment income, you might be able to save in a Solo 401k (or one-person 401k plan). Many types of self-employment qualify, especially if you actively earn income: walking dogs, freelancing, and consulting gigs are all viable options. You might be able to save up to 100% of your net earnings (up to certain limits), which helps you make a nice dent in your retirement savings.
Save in taxable accounts: Annual IRA limits don’t enable you to make a substantial contribution toward a comfortable retirement. If you’ve maxed out and you want to save more, you can always save in standard “taxable” accounts. These non-retirement accounts won’t offer much in the way of tax benefits, but they’re far superior to not saving. At some point, you may be able to shift funds from those accounts into retirement accounts (if your employer ever sets up a plan or you start your own 401k and business). You can even move funds indirectly by living off your taxable account and contributing as much income as possible to the retirement plan.
Health Savings Accounts (HSA): If you have a qualifying high-deductible health plan, you might be able to use an HSA to accumulate retirement savings. Those accounts have unique triple-tax benefits: The money goes in pre-tax, growth is tax-deferred, and distributions are tax-free when you follow all IRS rules. If you’re eligible to contribute, HSAs are an excellent tool for retirement savings because you don’t need to spend the money you contribute each year (there’s no use-it-or-lose-it feature). Instead, you can keep funds invested for long-term growth. It’s highly likely that you’ll have healthcare costs in retirement, so HSA funds should be useful.
If you want help starting your retirement savings, I’m happy to help. But you can also do it yourself, and here are some resources that may be useful:
- Free access: Where to Open an Individual 401(k) — Handout and Video. Get my insight on the key factors that matter to most business owners, the top five SoloK providers, and key pros and cons. A brief e-Book to save you time when choosing a solution. Also, you receive a link to a pre-recorded video covering the key mistakes to avoid when using a Solo 401(k).
- Download: If you’re more interested in IRAs, check out this short handout on where to open an IRA (my top three choices).
Important: This page touches on complicated topics related to tax and employment law. The information on this page might not be accurate, up-to-date, or relevant to your situation. Do not make important decisions based on what you read here. Instead, speak with an expert who has a detailed knowledge of your situation and any applicable regulations.