Providing a retirement plan for your employees shows that you are invested in their futures. 401k plans give employees the opportunity to plan ahead and care for their financial futures.
401k Basics for Employers
A 401k is a type of retirement account, aptly named after its section description in the IRS tax code (26 U.S. Code § 401(k)).
According to the Internal Revenue Service (IRS) legislation dictates that employers may provide employees with an option to receive their earnings in cash or in a deferred compensation structure.
401k Things to Know & Plan Types
There are two main ways that employees can contribute to a 401k plan.
The first option that employees have when they create a 401k plan is to do so on a pretax basis.
This means that any deferrals that come out of an employee's paycheck do so prior to any applicable taxes being taken out.
Alternatively, employees can also contribute to their 401k on a post-tax basis. Using this option means that all taxes that are taken out of their pay are deducted prior to making the contribution.
The IRS provides help to employees on how to select the right 401k plan.
Traditional 401k Plan
When employees choose to contribute to their 401k using a pre-tax method, it is often referred to as a traditional 401k plan.
The traditional 401k plan allows employees to contribute part of their regular compensation into a retirement fund, automatically, on each paycheck. The same goes for all 401k plans, but with one twist.
Using the traditional method, employees decline to have taxes deducted from their paychecks prior to making their 401k contribution.
The one thing employees need to remember, however, is that the tax will be deducted from their 401k when they reach retirement age and withdraw money from the account.
For many people, this is not the preferred method, as you may not know for certain how much money is in your 401k at any one time since taxes have not yet been deducted. In this regard, many employees opt to use the Roth method.
Roth 401k Plan
Employees that don't want to deal with tax deductions when they retire and want access to their 401k can opt for the Roth 401k plan instead of a traditional plan.
Employees who decide to use the Roth method for their 401k plan pay tax deductions on the contributions that they make to their 401k at the time of the contribution.
The upside to using this method is that when employees go to make a withdrawal from their 401k after retirement, they no longer need to pay tax deductions on the withdrawn funds since those deductions have already been made.
This method is typically favored, especially in lower-income employees with lower tax rates, as the chance of tax rates being greater when it is time to retire is possible.
Simple 401(k) Plan
For smaller employers, there is a third option when it comes to choosing a 401k plan, and it is called a SIMPLE 401k.
The rules and laws for SIMPLE 401k plans are laid out by the IRS.
401k Employer Contributions
Employers have the option to match (up to a specified amount) of an employee's contributions to their 401k. These are referred to as employer contributions.
Typically, employers who make matched 401k contributions do so by specifying a percentage amount that they will match.
Example: An employer with a 10% match, would match 10% of each contribution made by the employee.
Many employers add this contribution match benefit to their 401k plan benefits, and it is something that many people look for in a job.
Non-Elective 401k Contributions
Rather than a match, employers may decide to make contributions on the behalf of their employees, regardless of how much the employee contributes. In this case, this is referred to as a non-elective contribution.
Employees that work for employers who practice non-elective 401k contributions will receive them regardless of whether or not they contribute themselves. As such, this type of contribution is often referred to as a type of profit-sharing.
401k Contribution Limits
it is important to remember that there are IRS 401k contribution limits that vary depending on taxpayer status. The IRS has also announced changes to 401k contribution limits for 2022.
401k Investment Options
When it comes to investing, employees have several options. These include:
- Mutual Funds
- And More
The best plans will include guidance to help employees retire by a targeted age of their choosing.
Sometimes employers will create an incentive to retain their employees for a minimum period of time by requiring that the employee remains with the company for a specified amount of time before reaping the benefits of the company match.
This is what the IRS refers to as vesting.
There are specific requirements regarding when and how employees can access their retirement funds. Generally, 401k distributions are allowed when:
- An employee dies, becomes disabled, or otherwise has employment terminated
- The plan terminates and no successor defined contribution plan is established or maintained by the employer
- The employee turns 59 and a half-years-old
Distribution rules can be difficult to maneuver, but typically it is the responsibility of the employee to understand the limits imposed on 401k plan distributions and withdrawals.
401k plans are a very popular and common employee benefit. Oftentimes, employees even expect 401k plans from employers.
Employers who can offer a 401k retirement plan should do so, as it is not only a good investment for the employee but the employer as well.
For employers who are struggling with 401k management, services and solutions from an HR and payroll company, such as the solutions from Payday HCM, can be of great help.
To learn how Payday HCM is already helping countless businesses with their 401k management, contact us today.