What Are Starter 401(k) Plans - The Complete Guide

In December 2022, Congress passed the Secure 2.0 Act, legislation aimed to help more Americans save for retirement. One of the changes included was the introduction of a new retirement plan called a starter 401(k), which will be available starting in 2024. A starter 401(k) is an employer-sponsored retirement plan. 

If an employer offers a starter 401(k), their employees will automatically be enrolled, and 3% of their salary will be diverted to an investment account. Employees can choose to opt-out or choose to increase the amount they defer up to 15% (or $6,000 per year, $7,000 for employees over 50). Unlike a traditional 401(k), employers cannot contribute to their employee savings in a Starter 401(k) plan.

How Are Starter 401(k) Plans Different From Traditional 401(k) Plans?

Starter 401(k) plans are a new type of employer-sponsored retirement plans, designed to make it easier and more affordable for small businesses to offer retirement plans to their employees. There are a number of difference between a starter 401(k) and a traditional 401(k):

• Lower contribution limits. The annual employee contribution limit for a starter 401(k) plan is $6,000, compared to $22,500 for a traditional 401(k) plan. Catch-up contributions for employees over 50 are also lower, at $1,000 per year compared to $7,500 per year for a regular 401(k) plan.
• No employer contributions. Employers are not allowed to make contributions to starter 401(k) plans.
• Automatic enrollment. Employees are automatically enrolled in a starter 401(k) plan, but they can opt-out if they choose.
• Simpler compliance requirements. Starter 401(k) plans are exempt from certain IRS non-discrimination tests, which makes them easier for small businesses to administer.

Here is a table that summarizes the key differences between starter 401(k) plans and regular 401(k) plans:

Overall, starter 401(k) plans are a good option for small businesses that want to offer retirement plans to their employees but do not have the resources to administer a traditional 401(k) plan. 

They are also a good option for employees who want to start saving for retirement but have a limited amount of money to contribute.

What Kind of Business Can Offer a Starter 401(k) Plan?

Starter 401(k) plans are designed for small businesses that do not currently offer a retirement plan to their employees. To be eligible to open a starter 401(k) plan, an employer must meet the following criteria:

• The employer must not currently offer a retirement plan to its employees. This includes any type of retirement plan, such as a traditional 401(k), a SEP IRA, or a SIMPLE IRA.
• The employer must have fewer than 100 employees. (This is determined by the number of employees the business had during the previous year.)
• The employer must be a for-profit business. Nonprofit organizations and government entities are not eligible to open starter 401(k) plans.

There are a few exceptions to these eligibility rules. For example, an employer that previously offered a 401(k) plan but terminated it may be eligible to open a starter 401(k) plan if they have not offered a retirement plan for at least 12 months. 

Additionally, an employer that is required to offer a retirement plan under state law may be able to choose between offering a state-sponsored plan or a starter 401(k) plan.

If you are a small business owner and you are not sure whether you are eligible to open a starter 401(k) plan, you should consult with a financial advisor.

What Are the Drawbacks of Starter 401(k) Plans?

While starter 401(k) plans have a number of advantages, there are also some drawbacks to consider:

• Lower contribution limits. The annual employee contribution limit for a starter 401(k) plan is $6,000, which is significantly lower than the $22,500 limit for a regular 401(k) plan. This means that employees have less opportunity to save for retirement in a starter 401(k) plan.
• No employer contributions. Employers are not allowed to make contributions to starter 401(k) plans. This is a major drawback, as employer matching contributions can be a great way for employees to boost their retirement savings. It can also be a powerful retention tool for employers in a tight labor market.
• Simpler plan design. Starter 401(k) plans have a one-size-fits-all design, which means that employers cannot offer employees different investment options or contribution rates. This can be a drawback for employees who want more flexibility in their retirement savings plan.
• Newness of the plan. Starter 401(k) plans are a new type of retirement plan, and there is less information available about them than there is about traditional 401(k) plans. This can make it more difficult for employers to choose and administer a starter 401(k) plan, and it can also make it more difficult for employees to understand the plan and make informed decisions about their retirement savings.

Is a Starter 401(k) good for your business? Schedule an appointment with our retirement planning experts and learn how you can start your employees on the right track for retirement savings.