Small businesses offer less in retirement plans than large businesses despite higher employee turnover
401(k) plans lead to higher employee retention, reducing costs for small businesses
Recent tax policy has incentivized small business owners to offer 401(k) plans to their employees
Background
A 401(k) is a retirement savings plan that is offered by 57% of private sector firms with fewer than 100 employees [1]. This compares to 86% of companies with 100 or more employees and 91% of companies with 500 or more employees. It is important to note that over half of private sector workers are employed by a business with 100 or fewer employees.
Small business owners often state employee turnover as one of the largest headaches in business operations. Per the Bureau of Labor and Statistics, businesses with 50 to 249 employees have the highest employee separation rate at 4.1%, closely followed by businesses with 10 to 49 employees at 3.8%. This compares to separation rates of 1.4% for employers with 5,000 or more employees [2].
How 401(k) Plans Improve Employee Retention for Small Businesses
Small businesses owners that offer 401(k) plans to employees experience higher employee retention rates and cost savings from reduced employee turnover. Employees feel more valued and are incentivized to stay with the company to receive the employer matching contribution.
According to online payroll and HR solutions provider Gusto [3], companies that offer 401(k) plans see meaningful decreases in employee attrition (increased retention) across different age groups and industries. On average, employees with an active 401(k) plan are 32% less likely to quit in any given month. The decreases in attrition from companies offering 401(k) plans is most pronounced within older generations such as the Baby Boomer cohort as well as the Personal Services industry which includes retail and food and beverage companies
Retention rates are higher in the first year of employment for companies that offer 401(k) plans. For instance, a typical employee has a 44% chance of remaining at a job without a 401(k) plan after 12 months. When the employee has a 401(k) plan, the likelihood that the employee will be at the job in 12 months increases to 62% which results in a 40% lower probability of an employee quitting by the end of the first year.
On Average, An Employee with a 401(k) has a 40%
Lower Chance of Quitting by the End of Year 1
Furthermore, retention rates are even higher in the first year of employment for companies that offer 401(k) plans to lower income employees. For a 30-year-old man making $30,000 a year in the Personal Services industry, there is a 37% probability of remaining at the job when there is no 401(k) versus a 57% probability of remaining at the job with a 401(k). This results in a 54% lower probability of an employee quitting by the end of the first year.
A 30-Year-Old Earning $30,000 Per Year Has a 54%
Lower Chance of Quitting by the End of Year 1
While there is a cost to a small business owner to set up and operate a 401(k), the savings small business owners receive in reducing replacement costs typically more than covers the operating expenses of a 401(k).
For example, consider a 20-person company paying a $95,000 average salary. Offering a 401(k) would lead to 3.6 fewer employees quitting in a year. While estimates vary on how much it costs to replace an employee, it is often 0.5x-2.0x of an employee’s annual salary to replace them. If we assume it costs 100% of an employee’s annual salary to replace them, it could cost the company $342,000 within one year to recruit and train the employees.
The cost of setting up a 401(k) plan varies due to various factors such as number of participants, employee salaries, match amounts, and fees however, the cost of setting up and running a 401(k) is likely far less than the aforementioned replacement cost of losing employees due to not offering a 401(k).
Tax Incentives for Small Business Retirement Plans
Small business owners are incentivized by the Federal Government to set up retirement plans for their employees. The SECURE Act 2.0, passed by Congress in 2022, made available three main tax credits for small businesses with 100 or less employees starting a retirement plan.
Startup Tax Credit
The Startup Credit covers certain types of costs that are associated with operating and setting up a new retirement plan. The Startup Tax Credit is up to $5,000 per year for three years for “qualified startup costs” which includes items such as recordkeeping fees, administration fees, vendor support, and employee education.
For small businesses with up to 50 employees, the credit is for 100% of qualifying expenses up to $5,000 annually. Small businesses with 51 to 100 employees have a 50% credit for the first $10,000 of qualifying expenses, up to $5,000 annually.
Auto-Enrollment Tax Credit
The Auto-Enrollment Credit incentivizes small businesses to include an automatic enrollment feature in their retirement plans. The credit of $500 per year for three years is designed to increase employee participation thru automatic enrollment unless they opt out.
It is worth noting that small businesses with existing retirement plans are eligible for the Auto-Enrollment Credit if they amend the plan to have an auto-enrollment feature.
Employer Contribution Tax Credit
The Employer Contribution Tax Credit encourages small businesses to contribute to their employee’s retirement plans by offsetting the cost of employer contributions. This credit is only eligible for employee accounts who have an annual salary of $100,000 or less. The highest credit amount for any given year is $1,000 per participating employee for five years.
It is required that the small business makes employer contributions to each eligible employee’s retirement plan to receive the tax credit.
We outline below how the Employer Contribution Tax Credit works for employers with 50 or less employees.
For any tax year, the applicable percentage is reduced by 2% for each employee in excess of 50 employees during the preceding tax year, up to 100 employees.
Conclusion
Small businesses face a difficult challenge in retaining top talent to grow their business. Fortunately, 401(k) plans for small business owners are designed to increase employee retention which saves on total costs for the small business. Recent changes in tax policy are designed to incentivize small businesses to offer their employees retirement plans.
Footnotes and Disclosure
[1] U.S. Bureau of Labor Statistics – Employee Benefits in the United States; March 2024
[2] U.S. Bureau of Labor Statistics – Job Openings and Labor Turnover; February 2025
[3] Gusto - One Secret to Retaining Top Talent? Offering Retirement Benefits; November 2022
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