Are 401(k)s Good for Business Owners or Employees?

There are many reasons why business owners feel they must have a 401(k) in our businesses. Sometimes we want to offer the benefits of a larger company to prove we are indeed on track to becoming bigger and more successful. Or perhaps we set up that retirement plan to attract, reward, or retain an employee we feel is critical to our business. Sometimes a 401(k) is suggested by a trusted advisor, such as a CPA, to get a tax deduction in a profitable year, or a broker who has noticed we are stable and profitable with a few employees.

While these are all good reasons to consider a retirement plan, what are the downsides? Let’s talk about a few:

Retirement plans can be expensive. I was just talking one of my clients out of a plan. His CPA suggested he could put away, before taxes, $77,000 for him and his wife, both in the business. What was not mentioned is that the cost of doing this was over $35,000 a year because of contributions to eligible employees to max out for him and his wife.

It is invested in the market. This may sound obvious, but as business owners there are times we cannot control our own business path. All 401(k) plans invest money in the stock market. That means we’re investing our dollars in hundreds or even thousands of companies we have absolutely no control over, thus: tons of risk. The above business owner has been in the market for the last 15 years and has not even doubled his contributions. Business owners have a lot of risk in their business, so why add another risky investment? Is that really diversification?

Retirement plans are a heavy responsibility to your employees. Besides the monetary responsibilities, this current environment requires that business owners, referred to as Plan Sponsors by the Department of Labor, are the fiduciaries of their company sponsored retirement plans. This means that the business owner(s), not the broker or mutual fund company, is responsible for the investment results of the plan and for the education on an ongoing basis for the employees. The business owner is in fact liable if an employee is dissatisfied with the plan investment results, fees charged, or the investment education supplied.  Ouch. For more on this, click here for the latest news.

As business owners, we are always scrambling for a tax deduction and we’re eager to grab it once it’s found. This may be short term thinking. Today's income tax rates are the lowest in four decades. Is it really in our best interest to accumulate hundreds of thousands, or even millions, of dollars in a place that can be taxed at will by the government—which, by the way is cash strapped and teetering on financial collapse every few years? 

So how do we make a decision if this is the right retirement vehicle for us as business owners? I would suggest speaking with someone in each area about the liabilities, not benefits, of a plan. Talk to an ERISA attorney, do some tax modeling with your CPA, and ask your financial planner if there are better options for you—and have them explain all possible options. Real estate, annuities, collectibles, cash value life insurance, bond portfolios… Leave no stone unturned. Due diligence is the key.

*All investment advice given by Jeanne Brutman is just opinion. Please consult with your financial professional for a more thorough discussion of what is appropriate for you.