Imagine you’re in on the ground floor of the next Google or Facebook. Who needs a 401(k) when you’re going to be a billionaire, or at least a multi-millionaire soon? If this is what you’re thinking, you may want to reconsider.
As the following graphic illustrates, startups have a high failure rate.
Startup Success Rates - After 4 Years
Depending upon your industry, your startup has varying possibilities of success after 4 years. Additionally, even if the company is still in business at the 4-year point, there’s no guarantee the business is profitable or will endure over the long haul. Your future as a future startup millionaire may not be certain.
Characteristics of a Startup
Before we examine the pros and cons of 401(k)s for start-ups, let’s look at the startup’s unique characteristics. Then we’ll explore how these factors influence the pros and cons of 401(k)s for startups.
- Typical workers at startups are younger than at more established firms.
- Startups don't normally have developed human resources (HR) departments and may lack knowledge about and experience with the breadth of HR topics (compensation, benefits, compliance, etc.)
- In many cases, startups offer higher than average salaries.
- Many startups are located in expensive cost of living areas such as San Francisco, Silicon Valley, and New York City.
- Salaries may include commissions, stock options and other types of compensation.
- Although startups may have venture capital funding, they’re rarely profitable.
- Startup investors want to see results and short-term business growth; not long-term employee benefit packages.
Pros of 401(k)s for Startups
Although founders and employers are frequently focused on becoming profitable, there are benefits for employees and employers to creating (for employers) and participating in (for employees) a 401(k).
Employee recruitment and retention: Research supports the adoption of a 401(k) as a recruitment and retention tool. The employment market for technology, computer and engineering professionals is competitive. These types of professionals have their pick of jobs, so adding additional benefits can help startup employers hire and retain top employees.
- How a Smart 401(k) Investment Strategy Can Help Recruit and Retain Workers
- Silicon Valley is Growing Up: What This Means for Startup HR
Long-term financial benefits for employees: Even employees who are focused on paying their rent and living expenses today may be enticed by a robust 401(k) program if they learn about the long term benefits. Should the company fail, the opportunity to walk away with thousands of dollars in a 401(k) plan is a strong inducement for the worker.
Tax breaks for the company: Money is especially important for startups, especially if the firm is not yet profitable. This tax break makes starting a 401(k) for a startup more feasible. Employers may qualify for a tax break if they offer a 401(k) plan. IRS form 8881 outlines the tax credit for startup employers.
High ROI benefit/perk: If you’re looking for a benefit that has a high “bang for your buck", a 401(k) plan for your entire company can cost less than half of a single person’s health insurance or a ping pong table, and matching is not required.
Employers’ fears about setting up a 401(k) are largely unfounded. Today there are a variety of low-fee, low-maintenance 401(k) options for an employer. Employers would benefit from comparing the benefits of setting up a 401(k) with the costs. It may be a surprise to find out how easy 401(k) set up is.
Cons of 401(k)s for Startups
Some of the pros for 401(k)s for startups may also viewed as cons!
Lack of financial literacy/lack of employee interest: Many startup employees are young and living in high cost of living areas, and therefore may not appreciate the value of a 401(k). Jackson, the 28-year-old software developer may not care about retirement, nor be enticed by a 401(k). Jackson figures that if the company goes under, he’ll just get another job, likely at an even higher salary.
Following on the coat-tails of the former ‘con’ Jackson and his friends may have priorities that are out of sync with saving for retirement. With expensive rents in many startup regions and high salaries, startup industry workers may believe that, in spite of their high salaries, after paying rent, they want to direct their remaining income towards more current needs (like debt), not on a distant retirement goal.
Startup founders and employees are busy: In many cases, the management (the founder, the CEO, the COO -- whoever is in charge of managing the 401(k)) is wearing many hats; gaining funding, implementing and fine tuning the product, as well as marketing and securing customers. Without an HR department, the startup management may not see the value in creating, maintaining, and ensuring compliance for a 401(k) for the company.
Cost of a 401(k): Many startup employers believe they can’t afford to pay for a 401(k) plan. Couple that idea with the belief that the plan doesn’t matter to employees, and employers may lack a desire to create a 401(k) plan for employees. Further, employers may lack knowledge and information about the availability of affordable 401(k) plans.
Is a 401(k) worthwhile for startups?
- With the advance in affordable 401(k) options for employers, there’s generally no reason not to set up a 401(k) for a startup.
- A few exceptions: If you have major cash flow concerns, or you don’t yet offer health insurance, these should be higher priority than a 401(k).
- If a company wants to grow beyond the startup stage, and develop into a profitable business, then attracting top talent and keeping the employees happy and productive should be a primary concern. A 401(k) can serve as an attractive part of a compensation package.
- Employers and employees will be happier if Jackson and his cohort understand how a few dollars per month into a 401(k) today can yield a relaxing and profitable retirement tomorrow. Younger employees will benefit significantly by creating a sound retirement fund as early as possible. Without the former cushion of defined benefit pension plans, today’s workers and employers need to prioritize their own retirement futures.