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401(k) Plans for Small Businesses

By April 14, 2025No Comments

Introduction
Image: A row of row boats. Text under the image: Traditional 401(k) plans are required to undergo testing each year to make sure the plans do not favor highly compensated employees (HCEs) and key employees over the rank-and-file non-HCEs. There are three primary tests: the actual deferral percentage (ADP) test, the actual contribution percentage (ACP) test, and the top-heavy test. The ACP and ADP tests are designed to compare plan utilization by HCEs and non-HCEs to ensure that usage is widespread and benefits all plan participants. The top-heavy test gauges the percentage of total plan assets that can be attributed to key employees. Article title: 401(k) Plans for Small Businesses

Offering a 401(k) plan can be a powerful tool for small businesses looking to attract and retain talent, boost employee satisfaction, and reduce tax liabilities. However, many small business owners are hesitant to establish retirement plans due to perceived complexities and costs—particularly when it comes to traditional 401(k) plans and their required annual testing. Fortunately, simplified plan designs such as the Safe Harbor 401(k), Qualified Automatic Contribution Arrangement (QACA), and Starter 401(k) have emerged to provide flexible, lower-maintenance solutions tailored for small business needs. This article breaks down each option, helping employers understand the key differences and choose the plan structure that aligns best with their business goals.

Safe Harbor Plan

In a traditional 401(k) plan, you’re not required to make employer contributions. Safe harbor plans allow you to avoid testing by making fully vested contributions on behalf of employees.

You have several options. First, you can make a nonelective contribution of 3% (or more) of pay for each eligible employee, even those who aren’t actively contributing. Alternatively, you can match employee contributions dollar for dollar up to 3% of pay and match contributions from 3% to 5% of pay at a 50% rate (the “basic match”). You also have the option of making an “enhanced” matching contribution that is at least as generous as the basic match.

Election change

With a safe harbor plan, you can decide as late as 30 days prior to the end of a plan year whether you’ll use the 3% nonelective safe harbor for that year, which could be useful if you want to see how your testing is progressing before you commit to a safe harbor contribution for the year. Alternatively, your plan may be amended as late as the end of the year following the plan year, but only if the nonelective safe harbor contribution is 4%.

Employee contributions

As with traditional 401(k) plans, employees in safe harbor 401(k) plans can contribute up to $23,500 in 2025, plus an additional $7,500 for those age 50 and older ($23,000 and $7,500, respectively, for 2024).

QACAs

A QACA is a safe harbor 401(k) plan with an automatic enrollment feature. While most of the rules applicable to safe harbor plans also apply to QACAs, there are some notable exceptions.

Under a QACA, an employee who fails to make an affirmative deferral election is automatically enrolled in the plan. An employee’s automatic contribution must be at least 3% for the first two calendar years of participation and then increase 1% each year until it reaches 6%. You can require an automatic contribution of as much as 15%.

Employees can change their contribution rate or stop contributing at any time and get a refund of their automatic contributions if they opt out within 90 days.

Your required employer contribution is either 3% of pay to each eligible employee or a dollar-for-dollar matching contribution up to 1% of pay and 50% on additional contributionsImage is text: The SECURE Act 2.0 signed in late 2022 ushered in two new tax credits for small employers adopting a retirement savings plan, one for plan startup costs and one for employer contributions. Now might be an ideal time to consider adopting a 401(k) plan for yourself and your employees to take advantage of these credits. Article title: 401(k) Plans for Small Businesses of up to 6% of pay. You may also impose a two-year vesting schedule (compared to immediate vesting in a safe harbor plan). And if you select certain default investments for employee contributions, you’ll generally be relieved of fiduciary responsibility for any losses your employees incur from those investments.

Starter 401(k) Plans

Employers with no other retirement plan (with limited exceptions) can adopt what’s known as a starter 401(k) plan. Designed to be low cost and easy to administer, starter 401(k) plans allow only employee contributions. Employees must be auto-enrolled at a minimum contribution rate of 3% (not to exceed 15%) and may contribute up to $6,000 in 2025 ($7,000 for employees age 50 or older).

Safe Harbor 401(k) QACA Starter 401(k) Which employers can adopt? All nongovernmental employers All nongovernmental employers All nongovernmental employers that do not currently sponsor a plan Employee elective contribution limit (2025) Lesser of $23,500 or 100% of compensation; additional $7,500 catch-up if age 50 or older Lesser of $23,500 or 100% of compensation; additional $7,500 catch-up if age 50 or older Lesser of $6,000 or 100% of compensation; additional $1,000 catch-up if age 50 or older Required employer contribution (compensation limited to $345,000 in 2024) ·Dollar-for-dollar match up to 3% of compensation, 50% match above 3% to 5% (enhanced match also available) OR At least 3% of compensation to each eligible employee ·100% vested ·Dollar-for-dollar match up to 1% of compensation, 50% match above 1% to 6% (enhanced match also available) OR At least 3% of compensation to each eligible employee ·100% vested after 2 years Employer contributions not permitted Discrimination testing Exempt from ADP test; exempt from ACP test if you make the safe harbor required contribution, don't match contributions over 6% of pay, and limit discretionary match to 4% of pay Exempt from ADP test; exempt from ACP test if you make the safe harbor required contribution, don't match contributions over 6% of pay, and limit discretionary match to 4% of pay Exempt Top-heavy testing Exempt if employer contribution limited to safe harbor required contribution; otherwise required Exempt if employer contribution limited to safe harbor required contribution; otherwise required Exempt Additional employer contributions permitted? Yes (discrimination testing may be required); generally 3-year cliff or 6-year graded vesting Yes (discrimination testing may be required); generally 3-year cliff or 6-year graded vesting Employer contributions not permitted Article title: 401(k) Plans for Small Businesses

Conclusion

With expanded plan options, reduced administrative burdens, and new tax credits available under the SECURE Act 2.0, there’s never been a better time for small businesses to implement a retirement plan. Whether you opt for a Safe Harbor 401(k), a QACA, or a Starter 401(k), offering a retirement benefit can support your team’s long-term financial well-being while also benefiting your business. To ensure your chosen plan aligns with your financial objectives and compliance requirements, it’s wise to consult a financial or tax professional. At Scarlet Oak Financial Services, we’re here to guide you through your options and help you build a plan that works for your business and your employees.

Scarlet Oak Financial Services can be reached at 800.871.1219 or contact us here.  Click here to sign up for our weekly newsletter with the latest economic news.

Source:

Broadridge Investor Communication Solutions, Inc. prepared this material for use by Scarlet Oak Financial Services.

Broadridge Investor Communication Solutions, Inc. does not provide investment, tax, legal, or retirement advice or recommendations. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on individual circumstances. Scarlet Oak Financial Services provide these materials for general information and educational purposes based upon publicly available information from sources believed to be reliable — we cannot assure the accuracy or completeness of these materials. The information in these materials may change at any time and without notice.