The Tax Benefits of a 401K Match

Readying your 2022 taxes? Here’s how your 401K match will impact them.

Spring is such as a wonderful time a year. Besides the slowly rising temperatures and the tiny rabbits hopping around the area, spring also is a time to prepare for the yearly tax return to Uncle Sam.

As the 2022 tax deadline looms in the near future (April 18, 2022); are you ready to fund your 401K to save for retirement?

Have you put all the important papers together to make the process easy? Do you have any questions before filing (or sending all the stuff to the accountant)?

Luckily this year your new employer has great benefits including a 401K and an employer match. So, what does this mean for your taxes?

Don’t Leave Free Money on the Tax Table

Many employers offer an employee match to their 401K. Although it may vary, the most common match is 3%. So, if you save a mere 3% your employer will match dollar for dollar up to 3%. Let’s say you are 35-year old making $60,000/year. Contributing to your 401K at 3% would be $1800/year and your employer would match with an additional $1800/year. If you contribute just $150/month the total savings in your 401K would be $3600/year.

Needless to say, it’s free money – no cost to you!

Let’s say you continue to participate it an employer-matched 401K plan at the same rate with the same salary until age 65 that’s over $100,000 of free money. Do you want to leave this money on the table? No, of course not!

You may be wondering, “what’s the catch”? Well, the only requirement for receiving employer-matched 401K funds is that you contribute money first. It’s that easy.

What are the tax advantages of 401 (k) contributions?

Employer-sponsored 401K retirement plans are an amazing benefit to an employee. Besides offering free money, the money contributed by the employee is taken from the paycheck pre-taxed. Because the traditional 401K uses pre-taxed dollars it will reduce your current taxable income, reducing the overall income tax owed without significantly reducing your take-home pay. This is a carrot the federal government is dangling (through the form of tax advantages) to encourage people to save for retirement.

Any employer-matched contribution to your traditional 401K is taxed-deferred which means you won’t have any tax implications for the 2022 tax year. This basically means that the money in the 401K account will not be taxed until withdrawn from the account, typically during retirement. The subsequent income tax will be paid based on income at the time of withdrawal.

What’s the difference between Traditional and Roth 401K?

In a nutshell, with the traditional 401K you pay no taxes on the contributions but rather on the withdrawals. This lessens your tax liability on your total income.

Another newer form of the 401K is a Roth 401K where employee contributions are made with after-taxed dollars but withdrawals are not taxed. A Roth 401K is a hybrid savings program. It is essentially a Roth IRA (employee contributed) combined with a traditional 401K (employer contributed).

For example, let’s say you contribute $2500 of your $60,000 salary. In a traditional 401K you would pay income taxes on $57,500 where in a Roth 401K income taxes would be owed on the whole $60,000.

It’s a pay now or pay later system.

The Roth IRA, pay now plan, has great benefits for those anticipating a substantial retirement savings. When withdrawing the monies in a Roth 401 IRA, no additional income tax is paid on either the initial investment or the monies accumulated over time. Any income from earned from capital gains, dividends, and interest is tax-free.

The traditional 401K, pay later, requires taxes to be paid at the time of withdrawal. Because of the ease of the program, the traditional 401K is the most common because it encourages retirement saving with little impact on take-home pay.

Just a little note. Since a Roth 401K requires the employer match to go into a traditional 401K it provides extra administrative demand. Therefore, most employers feel the traditional 401K is the easiest, most cost-effective option for their employees.

Do I owe taxes now on the employer 401K match?

No. Regardless of the type of 401K program, the monies contributed by the employer are tax-deferred.

An employer-paid contribution placed into your 401K retirement account will be taxed upon withdrawal. If your employer-sponsored retirement account happens to be a Roth 401K, the employer contribution is actually held in a traditional 401K. If you have a traditional 401K everything – both your contributions and your employers matching contributions – will be held in the same account.

Why do employers offer 401K matching as a benefit?

Long gone are the days when people are employed by one employer for thirty or forty years. Many employees stay with a company less than five years. So why do companies offer 401K matching as an employee benefit?

“I want a raise.”

If you give an employee a much-deserved raise or bonus the employee now must pay additional income tax. Unfortunately, this might not be the best financial option for the employer. They must pay Social Security, Medicare, unemployment and other taxes. In the end the employee faces an average 22% tax burden and the employer a 9% tax burden.

Let’s say an employer offers a $2,000 year-end bonus. In the end the employer pays nearly $160 in taxes the employee will end up with only $1550 in their pockets.

Providing contributions to a 401K matching program not only provides the employee with greater retirement savings, it also proves to be a financial benefit in the form of tax advantages for the employers. You can call this a win-win!

What are the tax advantages of a 401K plan for employers? 

Many would love to think of their employers as looking out for their best interests. Although there are employers with on-site gyms and espresso bars, most employers are primarily focused on making money and retaining employees than keeping them happy.

Luckily, for employers there is an advantage to offering employee-matched contributions to retirement plans. For every dollar a company contributes to a qualified 401K plan for an employee the dollar is tax-deductible.

This is a huge benefit for the company to limit their tax liabilities.

In order to help smaller companies afford 401K retirement plans for their employees, the federal government provides tax advantages. This is just one of the ways companies “make” money by reducing expenses. Voilà!

Providing tax write-offs for setting up and contributing to 401K retirement plans may not be the only benefit to employers. Some companies believe these plans reduce employee turnover, increase work productivity, lower recruiting costs and create an overall happier employee. Fortunately, there’s plenty of data to prove this to be true.

Because of the tax benefits to the companies for providing matching funds for 401K retirement programs, many are choosing to have higher matching amounts. In an article dated February 9, 2022 from U.S. News and World Report (k)s/articles/companies-with-the-best-retirement-plans some companies are offering up to a 10% match in their retirement with a maximum of $10,000/year. In fact, Citigroup, who matches up to 6% of annual pay, will contribute 2% of annual salary with zero employee contribution.

Another article published by highlights 24 companies with great 401K plans. (k)/companies-with-great-401 (k)-plans/. In addition to the 401 (k) matching employee benefit, many of these companies had other “out-of-the-box” perks such as adoption benefits, fertility benefits, flexible work schedules, unlimited paid time off, wellness programs and more.

Who benefits in the 401K matching game?

EVERYONE. It’s a Win-Win!

The employee wins because they are given “free” money to save for retirement. Also, the employee contribution to the 401K is taken out pre-taxed so the impact on the employee’s paycheck is minimal.

The employer wins because a 401K matching program encourages employees to save for retirement. Companies are also provided federal tax advantages for providing for and contributing to the 401K programs. It’s a great perk that also saves the company money.

Have you contributed to your company’s 401K program? If not, what are you waiting for?

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