Why Have a 401(k)?

What financial advice have you been given?

Throughout my life I received 2 main pieces of financial advice.  1) Save for my own retirement.  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?

I would encourage you to actually contribute more than that to your 401(k) plan, as long as you can afford to do so.  In a previous blog post, Plan For Your Retirement: No One Else Will, I discussed why you should contribute to your own retirement and the significant advantages to doing so.  Please read that post and see why you should contribute what you can afford to your qualified retirement plan.

But what is in it for employers?  As an employer, why should you set up a 401(k) plan and put your money into your employee's retirement fund?

• $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.

If you would like to discuss the tax benefits of establishing and operating a 401(k) plan, or you have any questions, please send me an e-mail.

I would also be happy to refer you to a great financial advisor who can discuss all the non-tax aspects of your existing 401(k) plan or help you to establish a new 401(k) plan.

I appreciate your feedback.  Please feel free to leave a comment below.