Contributing

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 important employee retention tool. Regardless of age, employees (as well as job seekers), are thinking 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 and 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 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.