401(k) Plan Costs, Design Options, and Tax Benefits: A Strategic Guide

Luke A. Palmer, CFP®, AAMS®, CRPS®, AWMA®, Owner and CEO

3 December 2025

Retirement benefits have emerged as a decisive factor in the competition for talent. For business owners, a well-designed 401(k) can simultaneously attract employees, reduce taxes, and build personal wealth. This guide examines the true costs of sponsoring a plan, the design options that determine who benefits most, and the substantial tax advantages SECURE 2.0 has created for small businesses.

The 401(k) framework rests on three pillars: employee deferrals (pre-tax or Roth contributions deducted from paychecks), employer contributions (matching or profit-sharing), and tax-deferred growth on all invested amounts. How a business owner structures each element determines both out-of-pocket costs and long-term value. With the right design, owners nearing retirement can shelter over $70,000 annually while receiving tax credits that offset startup and contribution expenses for up to five years.

Plan costs scale inversely with assets and participation

The economics of 401(k) administration favor larger plans, a reality small businesses must factor into their planning. Total plan costs for a $500,000 plan with 50 participants typically run 2.0%–2.5% of assets annually, while a $5 million plan with 100 participants averages just 0.8%–1.2%. This disparity stems from fixed administrative costs being spread across a smaller base.

Cost Category	Small Plan ($500K–$1M)	Mid-Size Plan ($5M)	Large Plan ($50M+)
Setup fees	$500–$2,000	$1,000–$3,000	$2,000+
Annual TPA/administration	$1,750–$3,500	$3,000–$5,000	Varies
Per-participant fees	$15–$80	$50–$175	$35–$75
Compliance testing	$500–$1,500	Typically bundled	Typically bundled
Financial advisor (AUM)	0.50%–0.69%	0.35%–0.47%	0.15%–0.25%
Investment expenses	0.40%–1.30%	0.30%–0.80%	0.10%–0.50%

Business owners must choose between bundled providers (single vendor handling recordkeeping, TPA, and investments) and unbundled arrangements (separate specialists for each function). Bundled services simplify administration and work well for smaller plans; unbundled structures offer greater customization and easier replacement of underperforming providers but require more oversight.

The question of who bears these costs affects both tax planning and employee relations. Roughly 80% of small businesses pay administrative costs directly rather than deducting them from participant accounts. This approach protects the owner’s typically larger balance from fee erosion while enhancing the plan’s value to employees. Investment expense ratios, however, are almost universally deducted from participant accounts regardless of the fee arrangement chosen.

SECURE 2.0 transformed auto-enrollment from option to mandate

Plans established after December 29, 2022, face mandatory automatic enrollment requirements beginning with plan years starting after December 31, 2024. New plans must enroll eligible employees at a default deferral rate between 3% and 10% of compensation, with automatic annual increases of 1% until reaching at least 10% (capped at 15%). Employees retain the right to opt out or select different rates.

Three exemptions narrow the mandate’s reach considerably. Businesses that normally employ 10 or fewer workers are exempt, as are companies less than three years old. SIMPLE 401(k) plans, church plans, and governmental plans also fall outside the requirement. The employee-counting methodology follows COBRA rules, with part-time workers counted fractionally.

For businesses not subject to the mandate but considering voluntary adoption, the $500 annual auto-enrollment tax credit—available for three years—offsets implementation costs while boosting participation rates that can help plans pass nondiscrimination testing.

Safe harbor designs eliminate testing headaches and unlock plan flexibility

The safe harbor framework offers a bargain: in exchange for minimum employer contributions, plans automatically satisfy the ADP and ACP nondiscrimination tests that otherwise limit how much highly compensated employees (including owners) can defer. Four distinct safe harbor approaches serve different business situations.

Safe Harbor Type	Employer Cost	Employee Deferral Required	Vesting	Best For
Basic match (100% on first 3%, 50% on next 2%)	4% max	5% for full match	Immediate	Cost-conscious employers
Enhanced match (100% on first 4%–6%)	4%–6%	4%–6% for full match	Immediate	Simplicity-focused employers
Non-elective (3% to all eligible)	3%+	None	Immediate	Low-participation workforces
QACA match (100% on first 1%, 50% on next 5%)	3.5% max	6% for full match	2-year cliff allowed	New plans with auto-enrollment

The Qualified Automatic Contribution Arrangement (QACA) merits particular attention for new plans already subject to SECURE 2.0’s auto-enrollment mandate. QACA combines automatic enrollment with safe harbor status at a lower employer cost (3.5% versus 4% for basic matching) while permitting a two-year cliff vesting schedule—a meaningful retention tool in high-turnover environments where immediate vesting results in contribution “leakage.”

Non-elective contributions (the flat 3% to all eligible employees regardless of participation) work best when workforce demographics suggest many employees won’t contribute even with matching incentives. This approach also supports more aggressive profit-sharing designs by establishing a contribution floor for rank-and-file employees.

Maximize Your Savings

Age-weighted and new comparability plans shift contributions toward owners

Business owners seeking to maximize their personal retirement contributions while minimizing costs for younger employees should evaluate cross-tested plan designs. These arrangements recognize that older participants need larger current contributions to achieve equivalent retirement benefits, since their money has fewer years to compound.

Age-weighted plans allocate contributions based on both compensation and age using actuarial factors. The effect can be dramatic: in a scenario where a 50-year-old owner and a 30-year-old employee each earn $50,000, and the total contribution budget is $6,000, a traditional pro rata allocation gives each $3,000. An age-weighted allocation might deliver $5,018 to the owner (84%) versus $982 to the employee (16%); identical projected retirement benefits, vastly different current contributions.

New comparability plans offer even greater flexibility by grouping employees into rate categories (owners, executives, staff) with different contribution percentages. The trade-off is a gateway requirement: non-highly compensated employees must receive at least 5% of compensation or one-third of the highest allocation rate, whichever is less. When owners are significantly older than their workforce and earn substantially more, new comparability designs can direct 80%+ of total contributions to owners while satisfying nondiscrimination requirements.

Profit-sharing amplifies tax-deferred savings beyond employee deferrals

Profit-sharing contributions occupy a separate bucket from employee 401(k) deferrals, enabling combined annual additions of up to $70,000 per person in 2025 ($72,000 in 2026). Unlike matching contributions, profit-sharing amounts are fully discretionary: employers can vary or skip contributions based on business conditions without amending plan documents.

The tax advantages compound quickly. Employer profit-sharing contributions are deductible up to 25% of total covered payroll and escape FICA and FUTA taxes entirely. For every $1,000 contributed to profit-sharing rather than paid as wages, employers save approximately $76.50 in payroll taxes—a 7.65% immediate return before considering income tax benefits.

Contribution timing rules provide additional flexibility: payments made after year-end but before the tax return due date (including extensions) qualify for prior-year deductions. A calendar-year business can make 2025 profit-sharing contributions as late as October 15, 2026, and claim the deduction on its 2025 return.

Four allocation methods govern how profit-sharing dollars flow to participants: pro-rata (equal percentage of compensation), integrated/permitted disparity (higher allocations above the Social Security wage base), age-weighted, and new comparability. Vesting schedules ranging from immediate to six-year graded create retention incentives—forfeitures from departing employees either reduce future employer contributions or are reallocated to remaining participants.

Contribution limits rise in 2026 while new Roth requirements take effect

The IRS has announced cost-of-living adjustments that increase most retirement plan limits for 2026, with one significant structural change taking effect simultaneously.

Limit	2025	2026	Change
Employee deferral limit	$23,500	$24,500	+$1,000
Catch-up contribution (age 50+)	$7,500	$8,000	+$500
Enhanced catch-up (ages 60–63)	$11,250	$11,250	No change
Total annual addition limit	$70,000	$72,000	+$2,000
Annual compensation limit	$350,000	$360,000	+$10,000
HCE threshold	$160,000	$160,000	No change

SECURE 2.0 created an enhanced catch-up provision for participants ages 60–63, allowing contributions of the greater of $10,000 or 150% of the regular catch-up limit. For 2025–2026, this equals $11,250—enabling workers in this age window to defer up to $35,750 annually ($24,500 + $11,250). This provision is optional; plans must affirmatively adopt it.

Beginning January 1, 2026, employees earning over $145,000 in FICA wages from the plan sponsor must make all catch-up contributions on a Roth (after-tax) basis. Plans without Roth features will bar affected high earners from catch-up contributions entirely. Business owners typically exceed this threshold and should ensure their plans offer Roth deferrals before year-end 2026. The wage threshold rises to $150,000 for 2027 catch-up determinations.

Tax credits can offset most startup and contribution costs for small employers

SECURE 2.0 created a credit framework that makes 401(k) adoption nearly cost-free for eligible small businesses during the first several years.

The Startup Cost Credit covers 100% of qualified administrative costs (setup fees, TPA fees, employee education) for employers with 50 or fewer employees, up to $5,000 annually for three years. Employers with 51–100 workers receive a 50% credit. This alone can eliminate out-of-pocket administrative expenses for most small plans.

The Employer Contribution Credit—a new provision separate from startup costs—provides credits of up to $1,000 per employee annually for employer contributions made on behalf of workers earning $100,000 or less. The credit phases down over five years: 100% in years one and two, 75% in year three, 50% in year four, and 25% in year five. A business with 20 eligible employees receiving $1,000 matching contributions each could claim $70,000 in total credits over five years.

The Auto-Enrollment Credit adds $500 annually for three years ($1,500 total) for plans that include automatic enrollment—available to both new plans and existing plans adding this feature.

Combined, these credits can exceed $85,000 for a small employer over the first five years of plan operation, fundamentally changing the cost-benefit analysis for businesses that have delayed 401(k) adoption.

Conclusion: aligning plan design with business objectives

The optimal 401(k) structure depends on workforce demographics, owner age and compensation, cash flow predictability, and retention priorities. Younger owners with similarly aged employees may find simple safe harbor matching sufficient. Owners approaching retirement with younger staff should investigate age-weighted or new comparability designs that can shelter substantially more of their income.

The current tax credit environment creates a window of opportunity. Businesses establishing plans now can offset startup costs entirely while receiving credits on employer contributions that make the effective cost of matching or profit-sharing contributions significantly lower than the nominal amounts. Those considering plan adoption should act before the enhanced startup credits expire.

These decisions benefit from professional guidance. A qualified retirement plan advisor can model different designs against actual workforce data, while a tax professional can optimize the interplay between contribution strategies and business tax planning. The complexity of cross-tested plans and SECURE 2.0 compliance makes expert assistance particularly valuable.

At Palmer Wealth Group, we specialize in helping business owners navigate these decisions with clarity and confidence. Our team brings deep expertise in retirement plan design, tax optimization, and long-term wealth building strategies tailored to your unique circumstances. If you’re considering establishing a new plan or evaluating whether your current arrangement truly serves your goals, we welcome the opportunity to explore how a strategic partnership might benefit you and your business.

Disclosures

This material is provided for educational purposes only and does not constitute investment, tax, or legal advice. Consult qualified professionals regarding your specific situation before implementing any retirement plan strategy.

Retirement plan contributions involve investment risk, including possible loss of principal. Tax laws are complex and subject to change. The tax credits and contribution limits described reflect current law and IRS guidance as of November 2025; future legislative or regulatory changes may affect these provisions.

Past performance does not guarantee future results. The examples provided are hypothetical illustrations and do not represent actual plan performance or guaranteed outcomes.

Endnotes

Internal Revenue Service, “COLA Increases for Dollar Limitations on Benefits and Contributions,” IRS Notice 2024-80 (November 2024) and IRS Notice 2025-67 (November 2025).
SECURE 2.0 Act of 2022, Pub. L. No. 117-328, Division T, Sections 101, 102, 603.
Internal Revenue Service, “Treasury, IRS Issue Final Regulations on New Roth Catch-Up Rule, Other SECURE 2.0 Act Provisions” (September 16, 2025).
S. Department of Labor, Employee Benefits Security Administration, “A Look at 401(k) Plan Fees” (September 2019).
401k Averages Book, 25th Edition (June 2025), benchmark data on plan costs and fees.
Internal Revenue Code Sections 401(k), 404(a), 411(a), 414(v), 414(w), 415, 45E, and 45T.

Commonwealth Financial Network® does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.

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