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Are 401(k) Contributions Tax Deductible for Employers?
Seize the tax deductions (and credits!). Contributing to employees’ 401(k) accounts may cost ...
Are 401(k) Contributions Tax Deductible for Employers? Seize the tax deductions (and credits!). Contributing to employees’ 401(k) accounts may cost less than you think. Vehicle expenses. Salaries. Office supplies. Rent. Utilities. Many business expenses can be claimed as tax deductions. But did you know that 401(k) plan contributions offer significant tax benefits, too? Read on to discover all the ways you can save on your tax bill. Snag the tax deductions Great news! Whether you decide to make employer matching contributions, profit sharing contributions, or safe harbor contributions to employee retirement accounts, they’re tax deductible. That means that you can subtract the value from your company’s taxable income. According to the IRS, employer contributions are deductible as long as they “don’t exceed the limitations described in section 404 of the Internal Revenue Code.” Wondering about the limits? Well, in 2020 the employer contribution limit is 25% of an employee’s compensation (eligible compensation is limited to $285,000 per participant). In addition, combined employer and employee contributions are limited to the lessor of $57,000 or 100% of the employee’s annual compensation. The tax benefits don’t end there… In addition to claiming big deductions by making employer contributions to your retirement plan, you can also save on taxes in a multitude of other ways. 1. 401(k) administration fees—Administrative fees are typically a business tax deduction. So not only does paying for administrative fees reduce the amount that comes out of individual 401(k) accounts, but they qualify as a business expense, thus reducing your business taxable income. 2. SECURE Act tax credits—Thanks to the Setting Every Community Up for Retirement Enhancement Act of 2019 (the SECURE Act), you may be eligible for valuable tax credits for small employers. Even more valuable than a tax deduction, a tax credit subtracts the value from the taxes you owe! Plus, you can claim these credits for the first three years the plan or feature is in place: Tax credit for new plans—You may now be able to claim annual tax credits of 50% of the cost to establish and administer a retirement savings plan, up to the greater of: $500; or the lesser of: $250 per eligible non-highly compensated employee eligible for the plan; and $5,000. (Up to $15,000 in tax credits over three years!) Tax credit for adding eligible automatic enrollment—Earn an additional $500 annual tax credit for adding an eligible automatic enrollment feature to your new or existing plan. (Up to $1,500 in tax credits over three years!) 3. Benefit from your own contributions—Plan on contributing to your own 401(k) plan? You’ll save on your own taxes, too! In 2020, you can contribute up to $19,500 to your 401(k), and if you’re age 50 or older, you can make additional catch-up contributions of up to $6,500. Select either: Traditional 401(k) contributions with pretax dollars to enjoy the benefits of tax-deferred saving; or Roth 401(k) contributions with post-tax dollars, enabling you to make tax-free withdrawals in retirement Plus, offering your employees matching, profit-sharing, or safe harbor contributions may mean that you can increase your own personal contributions. That’s because, due to the mechanics of discrimination testing, higher 401(k) contributions made by non-highly compensated employees may help to increase allowable contributions for highly compensated employees. Learn more now. Reward your employees (and improve your company’s productivity) In addition to helping retain existing employees, a match is a powerful recruitment tool. In fact, a recent Betterment for Business study found that, for more than 45 percent of respondents, an employer’s decision to offer a 401(k) match was a factor in whether or not they took the job. Plus, you’d be surprised at the hidden costs of not offering an employer contribution. Just look at employee replacement and retention costs. When employers do not help facilitate employee retirement planning, they may be surprised by other costs that could rise, including higher relative salaries (beyond what might have been planned for), higher healthcare costs, or costs associated with loss of productivity. If the connection seems hard to believe, take a look at the research. According to a study from Prudential, every year an employee delays their retirement, it can cost their employer more than $50,000 due to a combination of factors including higher relative salaries, higher health care costs, younger employee retention through promotion, and several other elements. For companies that may be less concerned with an aging employee population, forgoing matches can still contribute to rising retention and replacement costs due to the impact of financial distress on employee performance. In a survey by the Society for Human Resource Management (SHRM), which measured the impact of personal financial stress on employee performance, 47% of HR professionals noticed that employees struggle with their “ability to focus on work.” Poor productivity not only costs the business in output, but can inevitably lead to higher employee turnover, which can lead to higher costs associated with retention and hiring. Make a smart compensation decision Are you debating between giving employees a raise and offering them a 401(k) plan contribution? Consider this example using $3,000. A $3,000 increase in base pay will mean a net increase to the employee of just $2,250, assuming 25% in income taxes and FICA combined. For the employer, that increase will cost $2,422.12, after FICA adjusted for a 25% in income tax rate. Employee Income After-Tax Employer Net Cost $3,000.00 Increased Pay $3,000.00 Increased Payroll ($750.00) Taxes @ 25% $229.50 FICA @ 7.65% ($807.38) Tax Deduction @ 25% $2,250.00 Net Paycheck $2,422.12 Net Cost Alternatively, a $3,000 contribution to an employer-sponsored 401(k) plan results in no FICA for either the employee or the employer. The employee would receive the full benefit of that $3,000 today on a pre-tax basis PLUS it would grow tax-free until retirement. As the employer, your tax deduction on that 401(k) contribution would be $750, meaning your cost is just $2,250 —or 7% less than if you had provided a $3,000 salary increase. Betterment can help boost tax savings even more... After you set up your 401(k) plan with Betterment, your employees can start investing for retirement and save on current taxes if they decide to save on a pre-tax basis. But Betterment provides additional tax saving strategies for those employees with two or more Betterment account types (including pre-tax 401(k) and Roth 401(k), but also a retail account) can have their investments optimized by using our Tax Coordination feature at no additional cost. This strategy generally places your least tax-efficient assets in your tax-advantaged accounts (like pre-tax 401(k)s), which already have big tax breaks, while diverting the most tax-efficient assets to your taxable accounts. …And help you take care of the paperwork You may be wondering: “Do I need to report 401(k) contributions?” The answer is “yes.” Specifically, employees’ contributions must be reported on their Form W2, Wage and Tax Statement, and Form W-3, Transmittal of Wage & Tax Statement. In addition, under the Employee Retirement Income Security Act of 1974 (ERISA), you are required to fulfill specific 401(k) plan reporting requirements, which include detailing employer and employee 401(k) contributions. While the paperwork can be complicated, an experienced 401(k) provider like Betterment can guide you through the process. Take the next step If you’re ready to get started, Betterment makes it easy for you to offer your employees a better 401(k) at a fraction of the cost of most providers. As your full-service 401(k) partner, we can help you: Design a plan with compelling features like automatic enrollment and employer contributions Select and monitor plan investments (Betterment assumes full responsibility as a 3(38) investment manager) Offer your employees personalized guidance to help them make strides toward their long- and short-term goals ranging from saving for retirement to paying down debt Manage important compliance and reporting requirements A Betterment 401(k) plan could be better for you—and better for your employees. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional. -
All About Vesting of Employer Contributions
Employers have flexibility in defining their plan’s vesting schedule, which can be an ...
All About Vesting of Employer Contributions Employers have flexibility in defining their plan’s vesting schedule, which can be an important employee retention tool. Regardless of age, employees, as well as job seekers, are thinking more than ever about saving for their future. 401(k) plans, therefore, are a very attractive benefit and can be an important competitive tool in helping employers attract and retain talent. And when a company sweetens the 401(k) plan with a matching or profit sharing contribution, that’s like “free money” that can be hard for prospective or current employees to pass up. But with employer contributions comes the concept of “vesting,” which both employees and employers should understand. What is Vesting? With respect to retirement plans, “vesting” simply means ownership. In other words, each employee will vest, or own, a portion or all of their account in the plan based on the plan’s vesting schedule. All 401(k) contributions that an employee makes to the plan, including pre-tax and/or Roth contributions made through payroll deduction, are immediately 100% vested. Those contributions were money earned by the employee as compensation, and so they are owned by the employee immediately and completely. Employer contributions made to the plan, however, usually vest according to a plan-specific schedule (called a vesting schedule) which may require the employee to work a certain period of time to be fully vested or “own” those funds. Often ownership in employer contributions is made gradually over a number of years, which can be an effective retention tool by encouraging employees to stay long enough to vest in 100% of their employer contributions. What is a 401(k) Vesting Schedule? The 401(k) vesting schedule is the set of rules outlining how much and when employees are entitled to (some or all of) the employer contributions made to their accounts. Typically, the more years of service, the higher the vesting percentage. Different Types of 401(k) Vesting Schedules Employers have flexibility in determining the type and length of vesting schedule. The three types of vesting are: Immediate Vesting - This is very straight-forward in that the employee is immediately vested (or owns) 100% of employer contributions from the point of receipt. In this case, employees are not required to work a certain number of years to claim ownership of the employer contribution. An employee who was hired in the beginning of the month and received an employer matching contribution in his 401(k) account at the end of the month could leave the company the next day, along with the total amount in his account (employee plus employer contributions). Graded Vesting Schedule - Probably the most common schedule, vesting takes place in a gradual manner. At least 20% of the employer contributions must vest after two years of service and 100% vesting can be achieved after anywhere from two to six years to achieve 100% vesting. Popular graded vesting schedules include: 3-Year Graded 4-Year Graded 5-Year Graded 6-Year Graded Yrs of Service % Vested % Vested % Vested % Vested 0 - 1 33% 25% 20% 0% 1 - 2 66% 50% 40% 20% 2 - 3 100% 75% 60% 40% 3 - 4 100% 80% 60% 4 - 5 100% 80% 5 - 6 100% Cliff Vesting Schedule - With a cliff vesting schedule, the entire employer contribution becomes 100% vested all at once, after a specific period of time. For example, if the company has a 3 year cliff vesting schedule and an employee leaves for a new job after two years, the employee would only be able to take the contributions they made to their 401(k) account; they wouldn’t have any ownership rights to any employer contributions that had been made on their behalf. The maximum number of years for a cliff schedule is 3 years. Popular cliff vesting schedules include: 2-Year Cliff 3-Year Cliff Yrs of Service % Vested % Vested 0 - 1 0% 0% 1 - 2 100% 0% 2 - 3 100% Frequently Asked Questions about Vesting What is a typical vesting schedule? Vesting schedules can vary for every plan. However, the most common type of vesting schedule is the graded schedule, where the employee will gradually vest over time depending on the years of service required. Can we change our plan’s vesting schedule in the future? Yes, with a word of caution. In order to apply to all employees, the vesting schedule can change only to one that is equally or more generous than the existing vesting schedule. Known as the anti-cutback rule, this prevents plan sponsors from taking away benefits that have already accrued to employees. For example, if a plan has a 4-year graded vesting schedule, it could not be amended to a 5- or 6-year graded vesting schedule (unless the plan is willing to maintain separate vesting schedules for new hires versus existing employees). The same plan could, however, amend its vesting schedule to a 3-year graded one, since the new benefit would be more generous than the previous one. Since my plan doesn't currently offer employer contributions, I don't need to worry about defining a vesting schedule, right? Whether or not your organization plans on making 401(k) employer contributions, for maximum flexibility, we recommend that all plans include provisions for discretionary employer contributions and a more restrictive vesting formula. The discretionary provision in no way obligates the employer to make contributions (the employer could decide each year whether to contribute or not, and how much). In addition, having a restrictive vesting schedule means that the vesting schedule could be amended easily in the future. When does a vesting period begin? Usually, a vesting period begins when an employee is hired so that even if the 401(k) plan is established years after an employee has started working at the company, all of the year(s) of service prior to the plan’s establishment will be counted towards their vesting. However, this is not always the case. The plan document may have been written such that the vesting period starts only after the plan has been in effect. This means that if an employee was hired prior to a 401(k) plan being established, the year(s) of service prior to the plan’s effective date will not be counted. What are the methods of counting service for vesting? Service for vesting can be calculated in two ways: hours of service or elapsed time. With the hours of service method, an employer can define 1,000 hours of service as a year of service so that an employee can earn a year of vesting service in as little as five or six months (assuming 190 hours worked per month). The employer must be diligent in tracking the hours worked to make sure vesting is calculated correctly for each employee and to avoid over-forfeiting or over-distributing employer contributions. The challenges of tracking hours of service often lead employers to favor the elapsed time method. With this method, a year of vesting is calculated based on years from the employee’s date of hire. If an employee is still active 12 months from their date of hire, then they will be credited with one year of service toward vesting, regardless of the hours or days worked at the company. If there is an eligibility requirement to be a part of the plan, does vesting start after an employee becomes an eligible participant in the plan? Typically, no, but it is dependent on what has been written into the plan document. As stated previously, the vesting clock usually starts ticking when the employee is hired. An employee may not be able to join the plan because there’s a separate eligibility requirement that must be met (for example, 6 months of service), but the eligibility computation period is completely separate from the vesting period. The only instance where an ineligible participant may not start vesting from their date of hire is if the plan document excludes years of service of an employee who has not reached the age of 18. How long does an employer have to deposit employer contributions to the 401(k) plan? This is dependent on how the plan document is written. If the plan document is written for employer contributions to be made every pay period, then the plan sponsor must follow their fiduciary duty to make sure that the employer contribution is made on time. If the plan document is written so that the contribution can be made on an annual basis, then the employer can wait until the end of the year ( or even until the plan goes through their annual compliance testing) to wait for the contribution calculations to be received from their provider. What happens to an employer contribution that is not vested? If an employee leaves the company before they are fully vested, then the unvested portion (including associated earnings) will be “forfeited” and returned to the employer’s plan cash account, which can be used to fund future employer contributions or pay for plan expenses. For example, if a 401(k) plan has a 6-year graded vesting schedule and an employee terminates service after only 5 years, 80% of the employer contribution will belong to the employee, and the remaining 20% will be sent back to the employer when the employee initiates a distribution of their account. -
Share the Wealth: Everything you need to know about profit sharing 401(k) plans
In addition to bonuses, raises, and extra perks, many employers elect to add profit sharing to ...
Share the Wealth: Everything you need to know about profit sharing 401(k) plans In addition to bonuses, raises, and extra perks, many employers elect to add profit sharing to their 401(k) plan. Read on for answers to frequently asked questions. Has your company had a successful year? A great way to motivate employees to keep up the good work is by sharing the wealth. In addition to bonuses, raises, and extra perks, many employers elect to add profit sharing to their 401(k) plan. Wondering if it might be right for your business? Read on for answers to frequently asked questions about profit sharing 401(k) plans. What is profit sharing? Let’s start with the basics. Profit sharing is a way for you to give extra money to your staff. While you could make direct payments to your employees, it’s very common to combine profit sharing with an employer-sponsored retirement plan. That way, you reward your employees—and help them save for a brighter future. What is a profit sharing plan? A profit sharing plan is a type of defined contribution plan that allows you to help your employees save for retirement. With this type of plan, you make “nonelective contributions” to your employees’ retirement accounts. This means that each year, you can decide how much cash (or company stock, if applicable) to contribute—or whether you want to contribute at all. It’s important to note that the name “profit sharing” comes from a time when these plans were actually tied to the company’s profits. Nowadays, companies have the freedom to contribute what they want, and they don’t have to tie their contributions to the company’s annual profit (or loss). In a pure profit sharing plan, employees do not make their own contributions. However, most companies offer a profit sharing plan in conjunction with a 401(k) plan. What is a profit sharing 401(k) plan? A 401(k) with profit sharing enables both you and your employees to contribute to the plan. Here’s how it works: The 401(k) plan allows employees to make their own salary deferrals—up to $19,500 per year (or $26,000 for employees over age 50) The profit sharing component allows employers to contribute up to $58,000 per employee (or $64,500 for employees over age 50), or 100% of their salary, whichever is lower. However, this limit includes employees’ 401(k) contributions, so typically, employers calculate their contributions keeping the $19,500 401(k) employee salary deferral maximum in mind. After the end of the year, employers can make their pre-tax profit sharing contribution, as a percentage of each employee’s salary or as a fixed dollar amount Employers determine employee eligibility, set the vesting schedule for the profit sharing contributions, and decide whether employees can select their own investments (or not) What’s the difference between profit sharing and an employer match? Profit sharing and employer matching contributions seem similar, but they’re actually quite different: Employer match—Employer contributions that are tied to employee savings up to a certain percentage of their salary (for example, 50 cents of every dollar saved up to 6% of pay) Profit sharing—An employer has the flexibility to choose how much money—if any at all—to contribute to employees’ accounts each year; the amount is not tied to how much employees save. What kinds of profit sharing plans are there? There are three main types of profit sharing plans: Pro-rata plan—Every plan participant receives employer contributions at the same rate. For example, every employee receives the equivalent of 5% of their salary or every employee receives a flat dollar amount such as $1,000. Why is it good? It’s simple and rewarding. New comparability profit sharing plan (otherwise known as “cross-tested plans”)—Employees are placed into separate benefit groups that receive different profit sharing amounts. For example, business owners (or other highly compensated employees) are in one group that receives the maximum contribution and all other employees are in another group and receive a lower amount. Why is it good? It offers owners the most flexibility. Age-weighted profit sharing plan—Employees are given profit sharing contributions based on their retirement age. That is, the older the employee, the higher the contribution. Why is it good? It helps with employee retention. How do I figure out our company’s profit sharing contribution? First, consider which type of profit sharing plan you’ll be using—pro-rata, new comparability, or age-weighted. Next, take a look at your company’s profits, business outlook, and other financial factors. Keep in mind that: There is no set amount that you have to contribute You don’t need to make contributions Even though it’s called “profit sharing,” you don’t need to show profits on your books to make contributions The IRS notes that the “comp-to-comp” or pro-rata method is one of the most common ways to determine each participant’s allocation. Using this method, you calculate the sum of all of your employees’ compensation (the “total comp”). To determine the profit sharing allocation, divide the profit sharing pool by the total comp. You then multiply this percentage by each employee’s salary. Here’s an example of how it works: Your profit sharing pool is $15,000, and the combined compensation of your three eligible employees is $180,000. Therefore, each employee would receive a contribution equal to 8.3% of their salary. Employee Salary Calculation Profit sharing contribution Taylor $40,000 $15,000 x 8.3% $3,333 Robert $60,000 $15,000 x 8.3% $5,000 Lindsay $80,000 $15,000 x 8.3% $6,667 What are the key benefits of profit sharing for employers? It’s easy to see why profit sharing helps employees, but you may be wondering how it helps your small business. Consider these key benefits: Provide a valuable benefit (while controlling costs)—With employer matching contributions, your costs can dramatically rise if you onboard several new employees. However, with profit sharing, the amount you contribute is entirely up to you. Business is doing well? Contribute more to share the wealth. Business hits a rough spot? Contribute less (or even skip a year). Attract and retain top talent—Profit sharing is a generous perk when recruiting new employees. Plus, you can tweak your profit sharing rules to aid in retention. For example, some employers may elect to have a graded or cliff profit sharing contribution vesting schedule to motivate employees to continue working for their company. Rack up the tax deductions—Profit sharing contributions are tax deductible and not subject to payroll (e.g., FICA) taxes! So if you’re looking to lower your taxable income in a profitable year, your profit sharing plan can help you make the highest possible contribution (and get the highest possible tax write-off). Motivate employees to greater success—Employees who know they’ll receive financial rewards when their company does well are more likely to perform at a higher level. Companies may even link profit sharing to performance goals to motivate employees. Employees love profit sharing It’s no surprise that employees love profit sharing. Retirement is one of the biggest expenses employees face—and it means a lot to know that their employer is contributing to their future. Get a profit sharing 401(k) plan your employees will love. What are the nuts and bolts of profit sharing 401(k) plans? The IRS clearly defines the rules for contributions, tax deduction limits, and other aspects of profit sharing plans. Here’s a quick overview of the most important regulations: Contribution limits—Employers can only contribute up to 100% of an employee’s compensation, or up to $57,000 per employee (or $63,500 for employees over the age of 50), whichever is lower. Calculation rules—When calculating an employee’s profit sharing contribution, only compensation up to $285,000 per year can be considered. Tax deduction limits—Employers can deduct profit sharing contributions from their taxes up to maximum contribution limits (generally, up to 25% of the total eligible compensation across eligible employees). Disclosure—Like with a typical 401(k) plan, employers must issue disclosures and file the appropriate forms with the Department of Labor and IRS. Deadline—Employers must make their contributions to the profit sharing plan by their company tax filing deadline (unless they file an extension). Are there any downsides to offering a profit sharing plan? Contribution rate flexibility is one of the greatest benefits of a profit sharing 401(k) plan—but it could also be one of its greatest downsides. If business is down one year and employees get a lower profit sharing contribution than they expect, it could have a detrimental impact on morale. However, for many companies, the advantages of a profit sharing 401(k) plan outweigh this risk. How do I set up a profit sharing 401(k) plan? If you already have a 401(k) plan, it’s as easy as adding an amendment to your plan document. However, you’ll want to take the time to think through how your profit sharing plan supports your company’s goals. Betterment can help. At Betterment, we handle everything from nondiscrimination testing to plan design consulting to ensure your profit sharing 401(k) plan is fully optimized. And as a 3(38) fiduciary, we take full responsibility for selecting and monitoring your investments so you can focus on running your business—not managing your retirement plan. Ready for a better profit sharing 401(k) plan? The information provided is education only and is not investment or tax advice.
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What Employers Should Know About Timing of 401(k) Contributions
What Employers Should Know About Timing of 401(k) Contributions One of the most important aspects of plan administration is making sure money is deposited in a timely manner—to ensure that employer contributions are tax-deductible and employee contributions are in compliance. Timing of employee 401(k) contributions (including loan repayments) When must employee contributions and loan repayments be withheld from payroll? This is a top audit issue for 401(k) plans, and requires a consistent approach by all team members handling payroll submission. If a plan is considered a ‘small plan filer’ (typically under 100 eligible employees), the Department of Labor is more lenient and provides a 7-business day ‘safe harbor’ allowing employee contributions and loan repayments to be submitted within 7 business days of the pay date for which they were deducted. If a plan is larger (>100 eligible employees), the safe harbor does not apply, and the timeliness is based on the earliest date a plan sponsor can reasonably segregate employee contributions from company assets. Historically, plans leaned on the outer bounds of the requirement (by the 15th business day of the month following the date of the deduction effective date), but today with online submissions and funding via ACH, a company would generally be hard-pressed to show that any deposit beyond a few days is considered reasonable. To ensure timely deposits, it’s imperative for plan sponsors to review their internal processes regularly. All relevant team members -- including those who may have to handle the process infrequently due to vacations or otherwise -- understand the 401(k) deposit process completely and have the necessary access. I am a self-employed business owner with income determined after year-end. When must my 401(k) contributions be submitted to be considered timely? If an owner or partner of a company does not receive a W-2 from the business, and determines their self-employment income after year-end, their 401(k) contribution should be made as soon as possible after their net income is determined, but certainly no later than the individual tax filing deadline. Their 401(k) election should be made (electronically or in writing) by the end of the year reflecting a percentage of their net income from self employment. Note that if they elect to make a flat dollar 401(k) contribution, and their net income is expected to exceed that amount, the deposit is due no later than the end of the year. Timing of employer 401(k) contributions We calculate and fund our match / safe harbor contributions every pay period. How quickly must those be deposited? Generally, there’s no timing requirement throughout the year for employer matching or safe harbor contributions. The employer may choose to pre-fund these amounts every pay period, enabling employees to see the value provided throughout the year and to benefit from dollar cost averaging. Note that plans that opt to allocate safe harbor matching contributions every pay period are required to fund this at least quarterly. When do we have to deposit employer contributions for year-end (e.g., true-up match or safe harbor deposits, employer profit sharing)? Employer contributions for the year are due in full by the company tax filing deadline, including any applicable extension. Safe harbor contributions have a mandatory funding deadline of 12 months after the end of the plan year for which they are due; but typically for deductibility purposes, they are deposited even sooner. -
The Small Business Guide to the 401(k) Match
The Small Business Guide to the 401(k) Match Choosing which benefit packages to offer your employees is a big decision. Let us guide you through the benefits of 401(k)s and matching contributions. There’s no denying that when a company offers its employees meaningful benefits, the company is often more successful at employee retention and employee happiness. According to employee benefits research done by Zenefits, companies that use benefits as a strategic tool for recruiting and retaining talent enjoy better overall company performance and above-average effectiveness in recruitment and retention compared to organizations that don’t. In fact: The majority of participants (51%) said they are “very unlikely” to accept a job that does not offer benefits 28% of respondents said they left a job because of poor benefits packages The key is to choose the right benefits package for your organization. 401(k) plans remain a consistent offering, and helping navigate retirement savings options can be a critical component of your overall benefits package. Financial perks as part of a benefits package Once a business owner determines the type of benefits plan they want to offer (here’s a benefits planning kit to get you started) and finalizes the details of their fiscal benefits, one of the big things to decide is whether to match employee contributions to the 401(k) plan. Determining whether or not you’ll offer a match is a big decision and there are many factors to consider when it comes to how the match is actually offered. While an employer contribution isn’t required by law, it’s a great way to show that you are invested in employees’ financial security. Whether you’re rolling out a retirement plan for the first time or brainstorming ways to upgrade your benefits package, there are the big factors to consider before introducing a 401(k) match, and what you need to know if you decide to offer one. If you’re making the effort and investment to offer a great benefit like a 401(k), research shows your employees are very likely to participate. Participation rates among workers who are offered a 401(k) varies depending on a variety of factors including age and rank. If you’re seeing low participation rates among your employees, offering a match is a great way to encourage enrollment. Should you offer a 401(k) match? Many small businesses think they can’t compete with larger companies, whose deep pockets seemingly afford everything—including a generous profit sharing or 401(k) match program. But in the retirement savings world, this isn’t always the case. Here are some reasons why a match program might be a good idea for your small business: Tax Benefits Employer contributions to employees’ 401(k) accounts are not subject to federal, state, and payroll taxes. Further, employer contributions are tax deductible, up to 25 percent of eligible compensation (and also subject to combined limits with employee contributions). Recruitment and Retention It’s no secret that the best talent expects the best compensation and benefits packages. Many seasoned professionals expect not only a great 401(k), but a plan that includes an employer match. Not offering a match could limit your talent pool and stifle growth. Productivity Happy employees perform better and generate higher profits. Employees are most productive when they aren’t faced with an uncertain financial future. A 401(k) plan makes it easier for employees to save and think long-term, and employer contributions offload some of the pressure to set aside disposable income. Studies show that happy employees are more productive, helping your bottom line. Types of Employer Contributions Businesses have a few options when it comes to offering a match. Here are the major types: For Peace of Mind: Safe Harbor Contributions A Safe Harbor 401(k) is designed to ensure all workers receive fair opportunity to benefit from the plan. A Safe Harbor plan design requires making contributions to an employee’s 401(k) as a percentage of their salary. It’s a costly upfront option, but it alleviates a lot of the pressures involved in compliance testing each year. Safe harbor contribution types include: Basic Match: Contribute 100% of employee 401(k) deferrals up to the first 3% of salary, then 50% of deferrals of the next 2% of each employee’s salary. Enhanced Match: Contribute 100% of employee 401(k) deferrals up to 4% to 6% of their salary. Non-Elective Contribution: Contribute at least 3% of each employee’s salary, regardless of their 401(k) deferral. For Flexibility: Discretionary Matching Contributions With discretionary matching contributions, you decide what percentage of employee 401(k) deferrals to match and what percentage of pay to match up to, with the flexibility of adjusting the matching rate as your business needs change. For example, many plans choose to match 50% of deferrals up to 6% of compensation. Keep in mind that a matching formula will be easy to enhance over time, but difficult to reduce without negatively affecting employee morale. For (More) Flexibility: Nonelective Contributions Each pay period, you have the option of providing a contribution to your employees’ 401(k) accounts based on salary, regardless of their contribution amount. A common type of nonelective contribution is profit sharing, which can either be a percentage of an employee’s salary or a lump sum, typically after year-end. This option is ideal when profits aren’t consistent, but you want to share success with employees when the company does well. Two of the most common profit sharing formulas are: Dollar Amount: For example, you allocate $1,000 to each eligible employee. Pro Rata (Comp to Comp): You allocate a fixed contribution amount among employees based on their relative salaries. It’s important to note that you can always start a 401(k) plan without a matching contribution and decide to add one down the road when it makes sense for your business. Even without a matching contribution, a 401(k) plan can be an effective tool to help your employees save for their future thanks to its beneficial features: Convenient. Employee contributions are made through payroll deduction, providing a built-in discipline that makes it easier to save. Tax-advantaged flexibility. Most plans allow employees to choose between making contributions on a pre-tax or Roth (after-tax) basis. This means employees can choose to defer taxes and reduce their current income or pay taxes now and make tax-free withdrawals of their contributions in the future. High contribution limits and no income limits. Compared to an Individual Retirement Account (IRA), a 401(k) allows individuals to save more than 3 times as much, without regard to income. This article is provided courtesy of Workest by Zenefits, one of Betterment’s partners. Zenefits helps employers stay on top of all HR, benefits, and payroll in a seamless affordable app. Zenefits believes in empowering small businesses, and offers Free Payroll for a year, for any business who needs it. -
The Importance and Benefits of Offering Employer Match
The Importance and Benefits of Offering Employer Match Some employees resist saving because they feel retirement is too far away, can’t afford it, or can’t grasp the benefit. You can help change that mentality by offering a 401(k) employer match. Beyond being an attractive employee benefit, a 401(k) plan can act as a catalyst for employees at all career stages to save for retirement. Some employees, however, will resist saving because they feel retirement is too far away, or can’t afford it, or can’t grasp the benefit to making room in their budget (and current spending levels). However, as a 401(k) plan sponsor, you can help change that mentality by offering a 401(k) employer matching contribution. What is a 401(k) employer matching contribution? With an employer match, a portion or all of an employee’s 401(k) plan contribution will be “matched” by the employer. Common matching formulas include: Dollar-for-Dollar Match: Carla works for ABC Company, which runs payroll on a semi-monthly basis (two times a month = 24 pay periods a year). Her gross pay every period is $2,000. She has decided to defer 4% of her pre-tax pay every pay period, or $80 (4% x $2,000). The ABC Company 401(k) plan generously offers a dollar-for-dollar match up to 4% of compensation deferred. With each payroll, $80 of Carla’s pay goes to her 401(k) account on a pre-tax basis, and ABC Company also makes an $80 matching contribution to Carla’s 401(k) account. At a 4% contribution rate, Carla is maximizing the employer contribution amount. If she reduces her contribution to 3%, her company matching contribution would also drop to 3%; but if she increases her contribution to 6%, the formula dictates that her employer would only contribute 4%. Partial Match (simple): Let’s take the same scenario as above, but ABC Company 401(k) plan matches 50% on the first 6% of compensation deferred. This means that it will match half of the 401(k) contributions. If Carla contributes $80 to the 401(k) plan, ABC Company will contribute $40 on top of her contribution as the match. Tiered Match: By applying different percentages to multiple tiers, employers can encourage employees to contribute to the plan while controlling their costs. For example, ABC Company could match 100% of deferrals up to 3% of compensation and 50% on the next 3% of deferrals. Carla contributes 4% of her pay of $2,000, which is $80 per pay period. Based on their formula, ABC Company will match her dollar-for-dollar on 3% of her contribution ($60 = 3% x $2,000), and 50 cents on the dollar on the last 1% of her contribution for a total matching contribution of $70 or 3.5%. The plan’s matching formula is chosen by the company and specified in the plan document or may be defined as discretionary, in which case the employer may determine not only whether or not to make a matching contribution in any given year, but also what formula to use. Is there a limit to how much an employer can match? The IRS limits annual 401(k) contributions, and these limits change from year to year. For 2020, employee contributions are limited to $19,500 (or $26,000 if you’re 50 or over). While employer contributions do not count towards these employee contribution limits, there is a limit for employee and employer contributions combined to the lesser of 100% of an employee’s gross compensation or $57,000 ($63,000 if you are 50 or over). It’s also important to note that the IRS caps annual compensation that’s eligible to be matched. Potential Benefits of Providing an Employer Match Attract talent: Offering a 401(k) is a great way to set your company apart from the competition, and a matching contribution sweetens the deal! A recent Betterment for Business study found that more than 45 percent of respondents considered a 401(k) match to be a factor when deciding whether to accept a job. Better 401(k) plan participation: Unlike other types of employer contributions, a matching contribution requires employees to contribute their own money to the plan. In other words, the existence of the match drives plan participation up (not contributing is like leaving money on the table), encouraging employee engagement and increasing the likelihood of having your plan pass certain compliance tests. Financial well-being of employees: A matching contribution shows employees that you care about their financial well-being and are willing to make an investment in their future. The additional funds can help employees reach their retirement savings goal. Reduced hidden costs: When evaluating the cost of an employer match, it is important to weigh long-term, less immediate benefits for the company. Without a matching contribution, employees may have to work longer than they otherwise would, which can lead to higher costs in the form of higher healthcare expenses, lower productivity and increased absenteeism, not to mention fewer promotional opportunities for other employees. Improved retention: The match is essentially “free money” that can be considered part of an employee’s compensation, which can be hard to give up. And by applying a vesting schedule to the employer match, you can incentivize employees to stay longer with your company to gain the full benefits of the 401(k) plan. Employer tax deduction: matching contributions are tax deductible, which means you can deduct them from your company’s income so long as they don’t exceed IRS limits. In addition to the combined employee and employer contribution limits mentioned above, there is an additional employer contribution limit which in 2020 was 25% of an employee’s compensation (eligible compensation is limited to $285,000 per participant). Offering a 401(k) plan is already a huge step forward in helping your employees save for their retirement. Providing a 401(k) matching contribution enhances that benefit for both your employees and your organization. Ready for a better 401(k) solution? Whether you’re considering a matching contribution or not, Betterment for Business is here to help. We offer a digital platform that makes it easy for you to set up and maintain a plan, with low cost administration, guided onboarding, and expert investment and administrative support. Any links provided to other websites are offered as a matter of convenience and are not intended to imply that Betterment or its authors endorse, sponsor, promote, and/or are affiliated with the owners of or participants in those sites, or endorses any information contained on those sites, unless expressly stated otherwise. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional. -
Understanding 401(k) Compensation
Understanding 401(k) Compensation Using an incorrect definition of compensation is on the top ten list of mistakes the IRS sees in voluntary correction filings. Compensation is used to determine various elements of any 401(k) plan including: Participant elective deferrals Employer contributions Whether the plan satisfies certain nondiscrimination requirements Highly compensated employees (HCEs) for testing purposes The IRS permits a plan to use multiple definitions of compensation for different purposes, but there are rules surrounding which definition can be used when. This is why using an incorrect definition of compensation is on the top ten list of mistakes the IRS sees in voluntary correction filings. General Definition of Plan Compensation There are three safe harbor definitions outlined in IRC Section 415(c)(3) that can be used to define “plan compensation” used to allocate participant contributions. W-2 Definition—Wages reported in box 1 of W2 PLUS the taxable portion of certain insurance premiums and taxable fringe benefits. The 3401(a) Definition–Wages subject to federal income tax withholding at the source PLUS taxable fringe benefits. The 415 Definition–Wages, salaries, and other amounts received for services rendered such as bonuses, and commissions. It also includes items such as taxable medical or disability benefits and other taxable reimbursements. In some contexts, the plan is required to use this definition for purposes of determining HCEs and the maximum permissible contributions. For all of these definitions, pre-tax elective deferrals are included in reported compensation. In addition, it’s important to note the annual cost of living adjustments on compensation as well as contribution limits by the IRS. These will impact the amount of allowable employer and employee contributions. Compensation for Non-Discrimination Testing As defined in IRC Section 414(s), this definition of compensation is primarily used for various nondiscrimination tests. Safe harbor match or safe harbor nonelective plans, for example, must use this definition to bypass the actual deferral percentage (ADP) and the actual contribution percentage (ACP) test. Each of the three 415(c)(3) definitions also satisfy the 414(s) compensation definition of compensation and can be used for non-discrimination testing. However, a 414(s) definition of compensation can include certain modifications that are not permissible where a 415(c)(3) definition is required. It is not uncommon for the 414(s) definition to exclude fringe benefits such as personal use of a company car or moving expenses. Exclusions of certain forms of pay must be clearly stated and identified in the plan document but may trigger additional nondiscrimination testing (known as compensation ratio testing) to make sure non-highly compensated employees are not disproportionately affected. Additional Compensation Definitions Pre-entry or pre-participation Compensation Plans that have a waiting or eligibility period may elect to exclude compensation earned prior to entering the plan from the compensation definition. This may help alleviate some of the financial burden associated with an employer match or profit-sharing contribution. Although such an exclusion would not trigger any compensation discrimination test, a plan that is deemed “top-heavy” (more than 60% of assets belong to key employees) must calculate any required employer contribution using the full year’s worth of compensation. Post-severance Compensation Post severance compensation are amounts that an employee would have been entitled to receive had they remained employed. It usually includes amounts earned but not yet paid at time of termination (bonuses, commissions), payments for unused leave such as vacations or sick days, and any distributions made from a qualified retirement plan. To be considered as post-severance pay eligible and included in the definition of plan compensation, amounts must be paid before the later of the last day of the plan year in which the employee terminated or two and a half months following the date of termination. Taxable Fringe Benefits Non-cash items of value given to the employee, such as the use of a company car for personal use, must be reported as taxable income. A plan can exclude taxable fringe benefits from its compensation definition and therefore not be subject to the compensation ratio test. Bonuses, Commissions, and Overtime These types of payments are considered plan compensation unless specifically excluded in the plan document. Many employers decide to exclude them because they are not regularly recurring, but should be aware that such exclusions will trigger the compensation ratio test. However, such exclusions must be specifically detailed in the plan document. For example, If a company offers a performance bonus, hiring bonus, and holiday bonus but decides to exclude the hiring and holiday bonuses from the definition of plan compensation, then it must be specific, since “bonus” would be too broad and include all types. Reimbursements and Allowances Allowances (amounts received without required documentation) are taxable, while reimbursements for documented and eligible expenses are not taxable. Allowances are therefore included in the definition of plan compensation while reimbursements are not. An allowance is generally considered a taxable fringe benefit so it is reported and follows certain rules above in regards to compensation definitions. International Compensation Tax implications can easily rise when dealing with international workers and compensation. Employers with foreign affiliates that sponsor non-US retirement plans still may be subject to the US withholding and reporting requirements under the Foreign Account Tax Compliance Act (FATCA) to combat tax evasions. Companies with employees who either work outside of the U.S. or who work in the U.S. with certain visas will need to carefully review each employee’s status and 401(k) eligibility. Rules and requirements vary by country. However, when 401(k) eligibility is based on citizenship or visa status, work location and compensation currency is not a factor. Define Plan Compensation Carefully Payroll is often a company’s largest expense, so it’s no surprise that companies devote significant time and energy to develop their compensation strategies. However, companies need to be mindful of the implications of their compensation program. Even simple pay structures do not necessarily translate into simple 401(k) plan definitions of compensation. It’s important to review the plan document carefully to be sure compensation definitions used reflect the desires of the company, that the definitions chosen are accurately applied, and that implications are clearly understood. Betterment is not a tax advisor, nor should any information herein be considered tax advice. Please consult a qualified tax professional. -
401(k) Automatic Enrollment: The Easiest Way to Help Employees Save
401(k) Automatic Enrollment: The Easiest Way to Help Employees Save If you’ve ever wondered if 401(k) automatic enrollment might be right for your employees, read on for answers to the most frequently asked questions. “Maybe when I turn 30.” “Maybe when I get a bonus.” “Maybe when I pay off my student loan.” “Maybe when my horoscope tells me it’s time to invest.” When it comes to enrolling in their 401(k) plan, employees often say “maybe later.” But the fact of the matter is the best time to save for retirement is right now because time (and the power of compounding) is on their side. That’s where 401(k) automatic enrollment comes in. If you’ve ever wondered if it might be right for your employees, read on for answers to the most frequently asked questions. What is 401(k) automatic enrollment? Automatic enrollment (otherwise known as auto-enrollment) allows employers to automatically deduct elective deferrals from employees’ wages unless they elect not to contribute. Simply put, it means your employees don’t have to lift a finger to start saving for retirement. How does automatic enrollment work? Typically, employees must go online, make a phone call, or submit paperwork to enroll in their retirement plan. It takes effort, and employees who are on the fence about enrolling might not take the time to do it. Before they know it, years have passed, and they’ve missed out on valuable time that they will never get back. However, you can automatically enroll employees and do all the work for them. If you decide to add an automatic enrollment feature to your 401(k) plan, you must notify your employees at least 30 days in advance. After you do, they can decide to: Opt out—Employees can “opt out” of 401(k) plan participation in advance (at Betterment, employees can do this easily online). Change the contribution amount or investments—Instead of just rolling with the default automatic enrollment elections, employees can elect their own contribution rate and investment funds. Do nothing—Employees don’t have to take any action. If they do nothing, once the “opt-out” timeframe has elapsed, they will automatically begin deferring a certain percentage of their pay to their employer’s plan. = As you can imagine, many employees do nothing, and as a result, start saving for their future (which is fantastic!). In fact, according to research by The Pew Charitable Trusts, automatic enrollment 401(k) plans have participation rates greater than 90%! That’s in stark contrast to the roughly 50% participation rate for plans in which employees must actively opt in. What are the different kinds of automatic enrollment? There are actually three different kinds of automatic enrollment arrangements: Basic Automatic Contribution Arrangement (ACA) When employees become eligible to participate in the 401(k) plan, they will be automatically enrolled at preset contribution rates. Prior to being automatically enrolled, employees have the opportunity to opt out or change their contribution rates. Eligible Automatic Contribution Arrangement (EACA) is similar to ACA, but the main difference is that employees may request a refund of their deferrals within the first 90 days. Qualified Automatic Contribution Arrangement (QACA) has basic automatic enrollment features. However, it also requires both an annual employer contribution and an increase in the employee contribution rate for each year the employee participates. For this reason, a QACA 401(k) plan is exempt from most annual compliance testing. If at first you don’t succeed, try again If employees opt out of 401(k) participation, that’s it, right? Well, not quite. According to the Plan Sponsor Council of America, in 2018, nearly 8% of plans annually re-enrolled employees who had previously opted out (that’s up from 4% that did so in 2013). What are the most common automatic enrollment elections? You have the freedom to select the percentage of employees’ compensation that is automatically contributed to the 401(k) plan. A 3% default contribution rate is still the most popular; however, more employers are electing higher default rates. That’s because research shows that opt-out rates don’t appreciably change even if the default rate is increased. And because many financial experts recommend a savings rate of at least 10%, using a higher automatic enrollment default rate gets employees even more of a head start. In addition to selecting the contribution percentage, you’re also responsible for selecting the default investments for employees’ deferrals. According to the IRS, you can help limit your investment liability by using default investments that meet certain criteria for transferability and safety, such as well-diversified funds or portfolios. What’s good (and not so good) about automatic enrollment? The best thing about automatic enrollment is that it helps employees—of all ages and salary levels—start saving for retirement. It makes saving for the future painless and productive (and offers significant tax advantages). Plus, an increased participation rate makes it easier for your plan to pass required compliance tests. However, there are a couple downsides to consider. When a plan uses automatic enrollment, often the default rate is set low (say around 3%). For most employees, this low saving rate may not be enough to live comfortably in retirement. But because employees didn’t actively choose the rate, they may not be inclined to increase it on their own. Wondering how to combat retirement saving inertia? Betterment can help by offering your employees personalized retirement advice. How can Betterment help? As an experienced 401(k) plan provider, Betterment can help your employees save for their futures with compelling plan design features like automatic enrollment and personalized financial advice. In fact, we offer employees specific advice on contribution rates, investment options, and which accounts to use (including those they may hold elsewhere). That way, even if your employees are automatically enrolled in the plan, they’ll get the advice and encouragement they need to boost their contribution rate, select appropriate investments, and save for the retirement they envision. Your employees deserve a better 401(k) plan. The information provided is education only and is not investment or tax advice. -
The True Cost of a 401(k) Employer Match
The True Cost of a 401(k) Employer Match Many companies are hesitant to start offering a 401(k) match program. Find out the truth behind matching employees’ 401(k) plan contributions. For a startup or a small business, 401(k) matches can seem like a worthy but unattainable benefit. Even larger companies may hesitate to offer a match if they haven’t previously provided one. According to SHRM’s 2017 Employee Benefits report, of the 90 percent of employers who offered a traditional 401(k) plan, 76 percent provided an employer match. So, while some executives may believe that matching employees’ 401(k) contributions is unpopular or will not be appreciated by employees, the evidence signals that neither is necessarily true. Believe it or not, employees tend to appreciate 401(k) matches. Employees often respond differently when they have a 401(k) match. Last year, EBRI and Greenwald & Associates’ found that nearly 73 percent of workers said they were likely to save for retirement if their contributions were matched by their employer. Let’s review the goals for employers offering a 401(k) match. First, matches are an important way employers can help employees stay on track for retirement; they can offer one way to build and extend an employee’s tenure with the company. Second, a match can add value to a 401(k) offering, helping to differentiate a total compensation package for job candidates. And these ideal outcomes aren’t just theory: A recent Betterment for Business study found that, for more than 45 percent of respondents, an employer’s decision to offer a 401(k) match was a factor in whether or not they took the job. That’s a relatively high demand for this type of benefit. Question the value of matches, but ask the right questions. Still, many employers tend to question the costs and benefits of matching 401(k) contributions. They often compare the value of a match to being more aggressive in their base salaries. And while making the right business move is critical, what many companies fail to evaluate effectively is the long-term cost of forgoing a match versus up-front costs of starting a match immediately. What are these long-term costs of forgoing a 401(k) match? Just look toward employee replacement and retention costs. When employers do not help facilitate employee retirement planning, they may be surprised by other costs that could rise, including higher relative salaries (beyond what might have been planned for), higher healthcare costs, or costs associated with loss of productivity. If these claims feel far-fetched, just look toward the research. According to a study from Prudential, every year an employee delays their retirement, it can cost their employer more than $50,000 due to a combination of factors including higher relative salaries, higher health care costs, younger employee retention through promotion, and several other elements. The storyline behind this find may be all too familiar to some employers: An older employee delays retirement due to insufficient savings; their productivity is hampered by health challenges, covered by employer-sponsored health insurance, and all the while, the company adapts to maintain productivity by hiring new people or advancing younger employees faster than anticipated. Eventually, when the older employer does retire, these costs only compound. These additional costs can sneak up on employers, aren’t always planned for effectively, and yet, they have a real business impact. For companies that may be less concerned with an aging employee population, forgoing matches can still contribute to rising retention and replacement costs due to the impact of financial distress on employee performance. In a SHRM survey measuring personal financial stress’s impact on employee performance, 47 percent of HR professionals noticed employees’ struggle with their “ability to focus on work.” Poor productivity not only costs the business in output, but it can inevitably lead to higher employee turnover, which, in turn, can lead to higher costs associated with retention and hiring. 401(k) matches may be your long-term competitive edge. Offering a 401(k) can be a step in the right direction, but whether you’re looking for ways to increase plan participation, design a good 401(k) plan or just help your employees focus on financial wellness, consider looking toward investing in a 401(k)-match program. With the costs that could be awaiting companies who don’t provide a match, maybe you can’t afford not to.