Benefits of a 401 (k) plan that you haven’t considered 401ks
As employers phased out traditional pension plans, 401 (k) plans were introduced to fill in the gaps. Named after the subsection of the Internal Revenue Service code that authorizes them, these accounts have become the primary vehicle for retirement savings for many people.
“Just having one is really important,” says Jodan Ledford, CEO of Smart USA, a global archivist who provides joint retirement solutions.
He points to data from the Employee Benefits Research Institute showing that those with access to pension plans are saving significantly more. EBRI’s 2020 Retirement Confidence Survey found that 51% of retirees with a pension plan had at least $ 250,000 in savings and investments, while only 5% of those without a plan took their retirement. retirement with this amount.
One of the reasons workplace pension plans are so valuable is that employers often match a percentage of employee contributions, which gives an immediate boost to retirement savings. However, there are also lesser-known benefits of 401 (k) plans that may be of interest to employers as well as employees.
Here are six 401 (k) benefits that you may have overlooked:
- Several tax benefit options.
- Contributions after tax.
- Financial safeguards.
- Automatic registration.
- Early loans and withdrawals.
- Ways to attract and retain the best talent.
Several tax benefit options
Depending on the plans offered by their employer, workers can choose to pay taxes on their retirement funds now or later.
Contributions of up to $ 19,500 to traditional 401 (k) accounts are tax deductible in 2021. Workers 50 and over can benefit from catch-up contributions for a total of $ 26,000 in tax-deductible contributions this year. The money grows tax-sheltered and then becomes subject to ordinary income tax when withdrawn in retirement. At age 72, retirees should start receiving the minimum required distributions, also known as RMDs, whether or not they need the money.
“The way I view the tax deduction is like IRS correspondence,” says Dan Hill, president and CEO of Hill Wealth Strategies in Richmond, Virginia. For someone in the 22% tax bracket, for example, every dollar contributed to a traditional 401 (k) could translate to 22 cents in tax savings.
Many employers also offer a Roth 401 (k) option. This new version of the 401 (k) plan does not offer deductions for contributions. The after-tax money is deposited into the account and withdrawals at retirement are then exempt from tax. There is no RMD with a Roth 401 (k).
Both accounts come with 401 (k) tax benefits, and which you choose will depend on your personal circumstances. For young workers who currently benefit from mortgage and child deductions and who could realize significant gains in their investments in the years to come, it may be wise to forgo an immediate tax deduction in favor of a Roth 401 (k ) which could result in substantial tax savings. later.
In addition to making deductible and Roth contributions to a 401 (k), workers have the option of making what are known as after-tax contributions. This capacity opens up other savings possibilities.
The first is a strategy known as the Roth “mega backdoor”. In 2021, the government is authorizing up to $ 58,000 in employee and employer contributions combined with a 401 (k) for young workers and $ 64,500 for those 50 and over. Those whose annual income is lower than these amounts are limited to contributions equal to 100% of their remuneration.
Assuming someone has maximized their tax-beneficial contributions, they could make up to $ 38,500 in after-tax contributions to a 401 (k) depending on whether and how well their employer matches up. Assuming it is authorized by the employer, this after-tax money can then be transferred to a Roth IRA so that future earnings can be withdrawn tax-free.
There is only a small percentage of workers who can afford to make contributions of this size. This means that the Roth mega backdoor strategy won’t benefit most workers, but it is a valuable tool for those in a position to use it.
However, after-tax contributions also hold promise as a way for workers to easily build up non-retirement savings. Some plans allow workers to make automatic after-tax contributions to their 401 (k) account that can be used for an emergency fund. This money can be accessed whenever needed, and any withdrawal of the principal amount can be made without having to pay taxes or penalties.
All 401 (k) plans must comply with the Employees Retirement Income Security Act, commonly known as ERISA. Therefore, employers have a fiduciary responsibility to create a plan based on the best interests of their employees.
Plan administrators cannot push investments that maximize profits. Instead, they need to make sure workers have access to stable funds with reasonable fees. They should also disclose information such as administrative fees and historical fund performance to help employees make informed investment decisions.
Employers should not let these requirements discourage them from offering a 401 (k) plan. “Online technology makes it easy,” says Denise Stefan, president of Engage PEO, an organization providing human resources solutions to small and medium-sized businesses. Companies can easily outsource plan administration to companies like Engage PEO if they don’t want to worry about the paperwork themselves.
For workers, another benefit of ERISA is that it protects the assets of creditors. In the event that a judgment is entered against a worker, assets held in qualified funds such as 401 (k) accounts cannot be entered. However, this protection does not extend to certain government garnishments, such as those relating to federal income tax or criminal fines.
The convenience of 401 (k) plans is an often overlooked benefit. Not only do payroll deductions make it easier to fund retirement savings, but many companies have also implemented automatic contributions for new employees.
When investing for retirement, it can be important to start early to maximize the gains. However, signing up for a 401 (k) plan is not always at the forefront of a worker’s mind when starting a new job.
To prevent workers from procrastinating, many companies now automatically enroll their workers in a 401 (k) plan. As a result, 93% of new hires at these companies save for their retirement, compared to 47% in companies that do not register automatically, according to a 2018 study by investment firm Vanguard. Some will also automatically increase the amount of a worker’s contribution each year.
Since these contributions are made through payroll deductions, it’s a relatively easy way to start saving for retirement.
Early loans and withdrawals
Normally, withdrawing money from a 401 (k) account before the age of 59 1/2 results in a 10% tax penalty. However, these plans have provisions that can turn them into a safety net in times of financial hardship.
“The best practice is, of course, to have emergency savings outside of the pension plan,” says Ledford. But if these are not available, taking a loan from a 401 (k) may be an option.
Generally, loans are capped at 50% of the acquired balance, up to a total of $ 50,000. Loan payments can then be repaid through convenient payroll deductions. However, if you quit your job, be aware that any outstanding balance must be paid off before the next tax filing deadline. Otherwise, the loan could become taxable and subject to the 10% penalty.
Money from a 401 (k) can also be accessed through hardship withdrawals for reasons such as medical care, tuition, and funeral expenses. Early retirees are also allowed to withdraw money from their account before the age of 59 1/2. This means that a person who leaves an employer at the age of 55 or later can take withdrawals for any reason without penalty.
Taking a loan or early distribution from a 401 (k) account can negatively impact your savings in the long run, so be smart using this financial tool. “I know people who have taken out loans for Harley Davidsons and swimming pools,” says Hill. These types of discretionary purchases are not a good use of retirement funds.
Ways to attract and retain top talent
While workplace pension plans have clear benefits for employees, business owners may ask: is 401 (k) worth it? The answer, according to some human resources experts, is yes.
“The 401ks are among the # 1 products that employees are looking for today,” says Stefan. Not only can they help a business attract skilled workers, but a good plan can keep them working.
The new group plans also make it easier for small businesses to provide retirement benefits to their employees. “The friction to put a plan in place is going to be alleviated,” says Ledford. Authorized by the SECURE law, group employer plans allow small businesses to come together to create the economies of scale that large businesses can benefit from in their retirement plans. Using a group plan provider can also simplify the process of setting up and administering a pension plan.
A 401 (k) plan comes with valuable tax benefits for employees as well as employers, but that’s not the only reason to love these accounts. They can also give you the tools to make smart investment decisions, create emergency savings, and more.