When it comes to employee benefits, one of the most sought-after yet difficult to understand is the 401(k). Many employees know that it’s a good thing, but they’re not sure why. In the same vein, many employers think that it’s a bad thing, but they’re not sure why either — beyond the idea that it’s just another way for their company to lose money.
If you’re an employer and you’re wondering whether you should offer your employees a 401(k), here is a short and easy guide about the benefit, and whether it’s something that’s right for your business.
What EXACTLY is a 401(k)?
The most important question to tackle is what exactly a 401(k) is. Studies have shown that many people aren’t sure what it is, or have no idea what it is at all! Simply put, a 401(k) is a type of benefit that employers can offer their employees. It is not mandatory, and it is completely up to the employer whether they will offer it or not.
401(k) plans work like this: eligible employees deposit tax-deferred contributions into the plan from their salaries. It can be on either a pre-tax or post-tax basis. Employers may then choose to either match their employee’s contributions or add non-elective amounts. Over time, the 401(k) will also accrue interest on a tax-deferred basis. Once the employee retires, they will be eligible to receive the whole amount from their 401(k), although some may choose to withdraw funds before they retire.
Differences between 401(k) and Pension
Many people often mistake the 401(k) with pension. This is probably due to the fact that both benefits are associated with retirement. However, there are distinct differences between the two:
- 401(k) plans are funded by employees, while pensions are funded by the employer. If an employer offers a 401(k), they can choose to either match the contributions made by their employees, or put in their own amounts.
- 401(k) plans allow employees to choose their own contribution amounts, while pension contributions are determined by the employer.
- 401(k) plans do not offer a guaranteed monthly paycheck after the employee retires. Pension plans guarantee a monthly amount for a specific period of time.
Since both 401(k) and pension plans are not mandatory benefits, an employer can choose to offer one, both, or none to their employees.
Myths about the 401(k) – and the Truth You Need to Know
As mentioned above, many employers don’t really understand how a 401(k) plan works, especially first-time and small business owners. Thus, there are many myths that surround the idea. Here are some of the more popular myths, and the truth behind them:
Myth 1: 401(k) plans are expensive and difficult to set up and maintain
There is SOME truth to this. 401(k) plans can be difficult and tricky to create, especially for large companies with many employees. There is so much paperwork and regulations to punch through, and many businesses don’t want to go through the time, trouble, or expense. However, there are now companies that offer affordable 401k administration services specifically for small business owners, which completely removes the burden from the employers for a reasonable fee.
Myth 2: 401(k) plans are only for large companies
While most 401(k) plans are being offered by large companies, this doesn’t mean that small business owners can’t benefit from these as well. One of the biggest reasons to offer a 401(k) is that these employers can enjoy significant tax deductions to their own business when they offer this benefit to their employees.
Myth 3: It’s difficult to match employee contributions
Since the 401(k) is completely elective on the part of employers, they can actually customize a contribution plan that will benefit both parties. They can decide to match the contributions or propose an amount. However, if they do match the contribution, they can opt for better tax deductions from the IRS.
Should I offer my Employees a 401(k)?
The bottom line when it comes to the 401(k) is that the benefits for both the employer and the employee far outweigh the drawbacks. Yes, it might be an added expense in the short term, but when you consider the long-term benefits such as sizable tax deductions and increased productivity due to higher employee morale and lower employee turnover rates, you can see how it can benefit your business. The trick here is being able to create the best possible 401(k) plan for you and your employee so that everyone wins!