An attractive benefit plan can play a fundamental role in recruiting and retaining qualified staff. And, when trying to save for the future, a 401(k) retirement savings plan can help employees attain their retirement objectives on a tax-advantaged basis. Named for the section of the Internal Revenue Code (IRC) that created it, a 401(k) plan may be one of the most popular and valuable fringe benefits available. Although the technical aspects of 401(k)s can be complex, the advantages can be far-reaching, including the following:
Plan participants receive a tax deferral for earnings on the contributions they make to their specific accounts under the plan, as well as for those made by employers on their behalf.
- Some employers offer matching contributions up to a certain percentage. This provides the plan participant with the opportunity to further enhance the tax-deferred accumulation of his or her
- plan assets.
- Plan participants may select from a variety of funding options. In addition, most plans allow employees to change their funding options over time to reflect their individual requirements.
- Since plan contributions are typically made on a pre-tax basis (subject to certain limitations), funds going into the plan are deducted from the employee’s salary before Federal income taxes. Consequently, by lowering taxable salary, participants are able to lower their Federal income tax each year they participate in the plan.
- Some plans also allow employees to make after- tax contributions (subject to certain limitations). While these contributions do not lower the current year’s income tax, as do pre-tax contributions, after-tax contributions also accumulate earnings on a tax-deferred basis.
How 401(k)s Work
401(k) plans are commonly referred to as defined contribution plans, because each plan participant has a separate account to which a specific or “defined” contribution is made. Employees determine how much they wish to contribute (not to exceed contribution limitations) and are able to choose among a variety of funding options offered by the plan.
In addition, employers may also contribute to employee accounts by matching a percentage of employee contributions. The advantage of matching contributions generally depends on the level of the match and the employer’s “vesting” requirements. Vesting refers to the employee’s entitlement to the funds in the plan. An employee’s contributions—and the earnings on those contributions—are fully vested from his or her start in the plan. On the other hand, an employer’s matching contributions may vest according to the employee’s length of service.
Read our blog post: The Basics of the 401(k) to find out more about this employer benefit.
A Certified Financial Planner™ can help you decode your 401(k) investment and make sure you are getting the most out of this valuable benefit.