Setting up a 401(k) plan for your climate startup

After medical, a 401(k) is one of the most important benefits that your employees and future hires will be looking for from your company. So, when you’re setting up a plan from scratch, how can you evaluate 401(k) providers? What are your key responsibilities as an employer, and the potential pitfalls you need to be aware of? 

Zach Stein is co-founder and CEO of Carbon Collective. We sat down with him to discuss why offering a 401(k) matters, the costs you can expect, and how to choose a plan. 

What is a 401(k)? 

A 401(k) is an employer-sponsored retirement plan. Before this model came into play, companies would put away a portion of employees’ paychecks into a pension plan, meaning they’d be guaranteed a set payout once they retired. With a 401(k), employees can choose whether to put a part of their paycheck away, which the company may or may not match. How much your employees put in, where they invest it, and how it performs over time will dictate how much they have when they retire. 

Since the decline of the pension plan, the government has been keen for employers to offer 401ks. To encourage adoption and protect employees’ interest, it’s put certain carrots and sticks in place:

The sticks

1. It may become mandatory as you grow
Some states require companies to offer their staff a plan once they reach a certain number of employees (usually 5). This doesn’t have to be a 401(k) – it could be a state-run Individual Retirement Account (IRA) plan. While generally a decent alternative, these have a few downsides including high fees for your employees, a smaller range of investment options, and a lower maximum contribution for individuals ($7,000 rather than $23,500).

2. The buck stops with you
The CEO is usually the fiduciary of a 401(k) plan, meaning they will be personally liable if something bad happens.

Fortunately, this will only be relevant in extreme situations – like at Enron, where most of the company’s 401(k) assets were part of its stock, so employees lost everything when it collapsed. As long as you stay away from illegal behavior and follow best practices, you shouldn’t have any issues. Put another way, just don’t do anything that blatantly prioritises the benefit of the company or its executives at the expense of your team.

The carrots

1. No income restrictions
A Roth IRA has income limits, so if you’re a high-income earner, you won’t be able to contribute. A 401(k) is available regardless of how much you earn.

2. Tax credits
For the first three years, small businesses can get tax credits that cover most, if not all, of the expenses around setting up a 401(k).

3. Hiring 
If you are looking to hire talent out of big tech, not having a 401(k) in place can be a red flag for high value talent. 

When to start up a 401(k) plan

You might need to start offering a 401(k) as early as Pre-seed if you’re particularly well-funded or recruiting from a talent pool who are more conservative or used to cushy benefits. You should definitely have one in place by the time you’ve raised a healthy Series A. 

Many founders assume that you have to offer an employer match when setting up a new 401(k). This is NOT the case. Most pre-seed and seed companies do not offer a match for cost reasons. We find this changes after the series A and it is unusual for a company that’s raised a B to not include a match.

The costs of setting up a new 401(k) plan

If you are looking to do an employer match, companies typically offer either a 3% or 4% match on employees’ contributions – either 3% to everyone, regardless of whether they contribute or not, or 4% to those who put at least that amount in. This structure is known as Safe Harbor. Multiply your payroll by 4% for an idea of what that will cost you.  A safe harbor match means that all employees can contribute without the risk of getting a refund because the plan wasn’t balanced.

But assuming you are not offering a match, like most seed and pre-seed companies, expect the 401(k) plan itself to cost $2,000 to $4,000 a year. Some, if not all of that could be withdrawn from the plan itself, but in the initial years it’s better to take advantage of tax credits.

Typically, your board won’t need to approve a 401(k) plan, but this depends on the policies you have in place. If your board would need to approve you switching to a new HR provider platform, then they’d want to approve this as well.

Choosing which 401(k) plan to work with

This decision usually starts with your HR system. If you’re in a professional employer organisation (PEO) they will often offer a 401(k) plan as part of their pool of services. Or, if you use a HR platform like Gusto or ADP, they will likely have a preferred or suggested 401(k) record keeper – the software you log into to access your 401(k) – but you can shop around as it will integrate with a variety of them. 

If you are in a PEO, you can still look around, but you’ll lose out on the value of the free or very low cost option the PEO offers. However, you’ll have the freedom to look for qualities that typically aren’t offered with a PEO, such as top-tier customer service and a fossil-free plan.

If you don’t want to go with the default options, several factors will influence your decision:

1. Cost
You’ll need to balance what the 401(k) plan offers with what you can afford. There are multiple “cookie cutter” low cost options on the market at this point. So long as you’re not trying to do anything fancy, you should be fine. But if you want to do more customization, including getting things like fossil fuel free options in your plan, then the default cookie cutter likely won’t be a good fit.

2. Customer service
401(k)s are not foolproof systems, and no matter who you choose, things will go wrong over the course of a multi-year relationship. You want to work with someone who is communicative and will work with you as a partner. The reality is that mistakes happen. You need to make sure that you  can be confident you will get the right support (or even the time of day) for handling any issues with your plan.

3. Climate-friendly options
Since they work in the sector, climate impact is probably important to your team when they’re deciding where to put their money, so you’ll need to look for a 401(k) record keeper that works with a 3rd party advisor that will build and monitor your fund lineup. You generally will need an advisor to help get more diverse fund options than the super generic ones. But a good advisor should always make sure you have access to those generic options too! 

Tips for getting the best 401(k) plan

1. Harness sales tactics
The 401(k) space is competitive,  so you can use classic sales tactics to your advantage.  For instance, if you can wait until the end of the quarter when sales reps are desperate to hit their target and earn a commission, you’re likely to be offered a better deal or a few free months. 

2. Ask for references 
Speak to people in your networks to get feedback on providers – e.g. Guideline, Betterment, Human Interest. They will be able to quickly warn you away from any that have major concerns, like horrendous customer service. Even if you’re going to go with a cookie-cutter platform or whatever your payroll provider offers, you’ll want to hear firsthand from someone who’s used it.

3. Weigh up what’s most important to your company
Your priority might be cost, customer service, or access to non-traditional investment options. Talk to your team. Talk to your leadership team. Get on the same page. Knowing your priorities up front before you start shopping around will make your decision much easier and faster.

Zach Stein is the co-founder of Carbon Collective Investing. He and his team have been selected by 140+ climate startups and mission driven orgs to be their 401(k) advisor.