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This is written by our friends at Ubiquity Retirement + Savings who have reimagined the 401(k) to offer better tax advantages and features, meaning bigger savings and more peace of mind for employers and employees.
In this article, we break down how the 401(k) reduces taxable income for both employers and employees, key features of the plan, and detail the next steps employers can take.
How does the 401(k) reduce taxable income for employers?
Ultimately, there are a plethora of direct and indirect tax benefits from 401(k)s for employers.
Tax deductions through more 401(k) contributions
When employers contribute to their employees' retirement accounts, they can deduct the amount contributed and lower their overall tax liability. For small business owners, this means you can reduce your taxable income while simultaneously investing in your employees' futures.
Administration fees write-offs
Costs related to ongoing maintenance (recordkeeping, compliance testing, etc.) are also tax-deductible. As a small business owner, you can offset some of the expenses associated with managing a 401(k) plan, making it more affordable to offer this valuable benefit.
Tax credits for setting up a plan
Small businesses may be eligible for tax credits that will help offset the costs of setting up a 401(k) plan (more on this below). These credits can significantly reduce the initial financial burden of establishing a retirement plan for your employees, making it more accessible for smaller companies.
Reduced payroll taxes
Employer 401(k) contributions aren't subject to Social Security and Medicare (FICA) taxes, meaning saving more while empowering their employees. For small business owners, this translates to lower overall payroll costs, which can be especially beneficial when managing tight budgets.
Tax deductions for employee education and communication
If employers spend money on any materials to educate their workforce about the 401(k) plan, these expenses can be written off. This encourages you as a small business owner to invest in financial literacy for your team, potentially leading to higher participation rates and better retirement outcomes for your employees.
Tax deductions for employee education and communication
If employers spend money on any materials to educate their workforce about the 401(k) plan, these expenses can be written off.
Summary of 401(k) tax benefits for employers:
These 401(k) tax advantages offer multiple benefits for small business owners beyond just financial savings.
By providing a robust retirement plan, you can significantly increase your hiring competitiveness, fostering greater employee loyalty and improving retention rates. This can be particularly valuable in today's competitive job market. Moreover, offering a 401(k) plan helps close the financial wellness gap among your workforce, promoting overall employee well-being and productivity. Importantly, as a small business owner, these plans also provide you with the opportunity to save for your own future alongside your employees. This dual benefit of supporting your staff while securing your personal financial future makes 401(k) plans an attractive option for small businesses looking to grow and thrive in the long term.
How the 401(k) reduces taxable income for employees
The major 401(k) tax benefits that employees gain access to include:
Tax-deferred contributions, fund growth, and withdrawals
This means any taxable funds are put off until a later time. So, employees can focus on saving more, and possibly be in a lower tax bracket by the time they start taking out money. This tax-deferral strategy allows your retirement savings to compound more efficiently over time, potentially resulting in a larger nest egg for your future.
Employer contributions, or "free money"
Employer matches are considered "free money" as they can significantly increase an employee's retirement savings, but it's only subject to taxes upon withdrawal (which is usually during retirement). Taking full advantage of your employer's match is essentially giving yourself a raise, boosting your overall compensation package without increasing your current tax burden.
Catch-up contributions
Employees who are 50 or older can make additional contributions to their retirement accounts. These can be made either pre-tax depending on how much they make, or after-tax with tax-free withdrawals. This feature allows older workers to accelerate their savings as they approach retirement, potentially making up for any earlier shortfalls in their retirement planning.
Loans or hardship withdrawals
While discouraged, some 401(k) plans allow employees to take out one of these two for when life happens. If paid back on time, no taxes may be owed on a loan, but hardship withdrawals can have different penalties depending on a plan's stipulations. These options provide a financial safety net for employees, allowing access to retirement funds in case of emergencies, though it's important to understand the potential long-term impact on retirement savings.
Summary of 401(k) tax benefits for employees:
Building on the benefits for small business owners, the advantages of 401(k) plans extend deeply into the employee experience as well.
These tax-advantaged retirement accounts serve as a cornerstone for personal financial planning, enabling workers to build substantial nest eggs over time. The ability to make pre-tax contributions not only reduces current taxable income but also allows for tax-deferred growth, potentially resulting in larger retirement savings. For employees, this translates to increased financial confidence and a more positive outlook on their long-term economic stability. Furthermore, the availability of catch-up contributions for older workers and the potential for employer matching funds create additional avenues for accelerated savings. By offering such comprehensive retirement benefits, companies foster a culture of financial responsibility and forward-thinking, which can lead to a more engaged, productive, and loyal workforce.
Ultimately, a well-structured 401(k) plan becomes a win-win scenario, aligning the financial interests of both the business and its employees for mutual long-term success.
401(k) plan features for employer tax savings
The following features can be discussed with a 401(k) provider to help you better understand how they'll align with your business needs.
Tax credits
Tax credits are an incentive for employees to set up and maintain a 401(k). The credits help decrease the overall costs of setting up a plan (legal fees, consulting fees, etc.), and can even help cover education and literacy efforts. If eligible, employers can get thousands of dollars back in credits.
If you're wondering about whether you'll be eligible for tax credits and what's available, you can discuss this with your chosen plan provider.
Helpful resource: 401(k) plan tax credit and cost calculator
Auto-enrollment credit
This standout credit allows an employer to claim hundreds of dollars in credits per year, for a 3-year period, if they adopt an eligible auto-enrollment plan. By automatically enrolling employees into their employer's plan, they are given the push to start saving more for retirement, earlier, and are more likely to meet their financial goals. And this essentially costs employers nothing to implement.
Secure 2.0
The Secure 2.0 Act, which was officially put into law in 2022, is designed to enhance retirement plans by allowing employers to offer more incentives that encourage participation. And, by providing employees more incentives such as emergency savings accounts employers have more options for reducing their taxable income with:
- Increased tax credits
- Streamlined plan administration
- Improved portability
- Flexible plan designs (more competitive packages without the penalties)
Safe harbor
401(k) plans are subject to IRS compliance tests, and the process of passing these can be very complicated and time-consuming. Safe harbor plans help simplify this problem by allowing employers to bypass testing (they automatically satisfy requirements), and can help with some big tax savings thanks to:
- Tax-deductible contributions
- Lowered administrative costs
- Higher contribution limits for key employees
When it's time to find your best-fit plan provider
Along with the significant tax saving benefits, a one-stop-shop plan provider can also help you with everything from compliance to recordkeeping. As you search for your best-fit provider, you'll want to make sure that your final choice can set you up for success from the get-go and provide all the resources you need to make building your retirement future as simple as possible.
Ubiquity is a prime example of a well-rounded provider you'll most likely run into. They boast transparent, low-cost plans, broad investment options, and flexible and user-friendly features that can boost tax savings, financial well-being, and overall business scalability. When they say they've got you covered, they mean it.
