Q. How does my employer benefit financially from offering a 401(k)? Is it worth contributing a plan with high expense ratios if the company offers no match? Also, some companies force everyone into the company plan through auto-enroll without their consent. Is this legal?
— 401(k) curious
A. Let’s start with the basics.
A 401(k) allows eligible employees to save for their retirement in a tax-advantaged account.
The amount that the employee specifies is deducted from their salary on a pre-tax basis, or if there is a Roth component, on an after-tax basis, said Jody D’Agostini, a certified financial planner with AXA Advisors/The Falcon Financial Group in Morristown.
“In both cases, the money is invested in the investment choices allowed in the plan, and it grows income tax free,” she said. “You are not taxed on the money until you start to take withdrawals — at age 59 ½ at the earliest or most likely at retirement — when presumably you are in a lower tax bracket.”
The employer may make contributions as well, but this aspect is optional, she said.
D’Agostini said there is still an advantage to participating even if the employer doesn’t offer a match because the pre-tax money that you save will reduce your taxable income by the amount invested and start you down the path for retirement income.
“The sooner that you start contributing the better, as the money will see the advantage of tax deferred growth for that much longer,” she said. “Longevity is the greatest risk we see in retirement – outliving your resources.”
Participants for 2017 could contribute up to $18,000 a year or $24,000 if age 50 or older, she said.
D’Agostini said the benefit to the employer is a tax deduction for any matching that occurs. Also, it’s a useful employee benefit to attract and retain valuable employees and it may reduce turnover.
It also allows the employer to contribute to his or her own retirement at thresholds that are higher than an IRA would allow, she said.
But there is a cost to the employer, who will pay fees to not only set up the plan, but to make sure that the plan stays in compliance with strict rules.
Each year, she said, the employer is required to send the participants a copy of the Summary Plan Description which gives information on the investment choices, fees, and other aspects of how the plan works.
Now to the auto-enroll option, which was created to increase participation and savings by employees in the retirement plan.
“Insufficient retirement savings is a significant problem in the U.S., where nearly a third of people over age 55 have no retirement savings, even as employer-provided pension plans have been on the decline,” she said. “Auto-enrollment, which is legal, is rapidly becoming a popular option in the 401(k) space and was initiated by the Pension Protection Act of 2006.”
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