Why Have a 401(k)?

May 2nd, 2016 Posted by Tax Planning 2 comments

Most financial experts will give you 2 main pieces of financial advice: 1) start saving for your retirement early, and 2) contribute enough to a 401(k) plan to maximize the employer match.

Every 401(k) plan is different as businesses set them up in order to best meet their needs and the needs of their employees.  However, a typical arrangement is for employers to match their employees contributions to their 401(k) plans $0.50 on the dollar, up to 3% of the employees gross salary.

If that is how your 401(k) plan works, you should contribute at least 6% of your gross salary to your 401(k) plan.  That effectively increases your salary by 3%! Why would you want to leave money on the table?

You should consider contributing even more than that to your 401(k) plan, as long as you can afford to do so.  As we discussed previously, due to compounding interest your retirement account can grow significantly.  The more you are able to contribute while young, the more growth you are likely to see.

401(k)

But why should an employer set up a 401(k) plan for the employees?  You may like the idea of helping your employees save for retirement, but do you want to deal with the cost and extra administrative burden?  That is up to you, but there are a few tax and non-tax benefits to setting up a plan:

$1,500 Tax Credit. Employers are entitled to claim a tax credit equal to 50% of the cost to set up and administer the plan, and to educate employees about the plan.  The credit is worth a maximum of $500 per year for each of the first 3 years of the plan.  If you are unable to use this credit in any given year, the unused portion can be carried back or forward to other tax years.  There are a few basic requirements that you should discuss with a CPA.

  • Tax Deduction.  Every penny that an employer contributes to a 401(k) plan, including to his or her own, is a tax deduction.  As an employer, you are also able to deduct the cost of administering the plan and educating your employees about the plan.  This is because the IRS considers the operation of a 401(k) plan to be an ordinary and necessary business expense.
  • Better Employee Recruitment and Retention.  For any business, having great employees is essential.  They represent you, so it is important that you are able to recruit the best possible employees and retain them once you have them.  All else being equal, I would choose to work for a company that has a 401(k) plan over one that doesn’t.  It shows employees that you care about them and their retirement.  It helps to build loyalty to your company.
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