The Power of Small Business 401(k) Plans

A 401(k)plan for small business allows workers to contribute pre-tax dollars to a retirement fund. With the future of Social Security uncertain, these employer-sponsored programs can help working Americans save for their retirement. They can also help a small business attract and retain employees.

There are three kinds of 401(k) plans that small businesses can offer their workers:

SIMPLE 401(k) Plan

The SIMPLE 401(k), also known as a savings incentive match plan for employees, was established for small business with 100 or fewer employees. These workers must have earned at least $5,000 in the year before they sign up for the plan. They cannot have another retirement plan under your company.

Under a SIMPLE 401(k), employers must match employee contributions dollar-for-dollar, up to 3 percent of the employee's salary. An employer must make a flat 2 percent compensation even if the employee does not make contributions to the SIMPLE 401(k). This is called a non-elective contribution.

For 2007, the maximum pretax employee contribution to a SIMPLE 401(k) is $10,500. Employer contributions must be fully vested, and employers cannot have another retirement plan if they offer a SIMPLE 401(k) plan.

Traditional 401(k)Plan

Businesses of any size can set up traditional 401(k) plans, which do not require employer contributions. Employers can also vest their contributions over time. However, businesses are required to conduct annual testing to show that benefits for lower-level employees are proportional to benefits for owners and managers. The maximum pre-tax contribution for employees in 2007 is $15,500 under a traditional 401(k). There is no maximum dollar-for-dollar amount for employer matching funds.

Safe Harbor 401(k)

Business of any size can also adopt safe harbor 401(k) plans. This type of retirement plan is similar to the traditional 401(k), except that business owners have to make matching contributions. However, businesses do not have to abide by non-discrimination rules that require annual testing.

Employers match contributions dollar-for-dollar up to 3 percent of an employee's income under the safe harbor 401(k). If an employee makes contributions beyond 3 percent, employers match 50 cents to every dollar that the employee contributed, up to 5 percent of the employee's income. You must contribute at least 3 percent of an employee's income to a safe harbor 401(k)plan, even if the employee does not make contributions.

Combined employer and employee contributions to an individual safe harbor 401(k) cannot exceed $45,000 in 2007.

Employers who offer safe harbor 401(k) plans must also notify eligible employees about the plan every year, describing the safe harbor 401(k), how to make contributions and other details about the scheme.