When employees contribute to their 401(k) accounts, they unlock some pretty sweet tax perks. But no less important are the potential tax benefits awaiting your own company by virtue of offering a 401(k) in the first place. We’re not a tax advisor, and none of this information should be considered tax advice for your company’s specific situation, but we’d be remiss if we didn’t lay out three key tax benefits awaiting companies in general by sponsoring a 401(k) plan:
- Company contributions are tax deductible
- Plan administration fees are (usually) tax deductible
- Small businesses can snag tax credits for starting a new plan and/or adding auto-enroll
Keep reading for more details on each opportunity.
Your company’s contributions to employees’ 401(k)s are tax deductible
When you contribute to your employees’ 401(k)s, you not only supercharge their retirement savings and boost the appeal of your benefits, you can deduct your contributions from your company’s taxable income, assuming they don’t exceed the IRS’s limit. That annual contribution limit is 25% of compensation paid to eligible employees and doesn’t change from year to year.
Compensation Pro-Tip: Consider a contribution over a raise
It’s for this reason that dollar-for-dollar, contributing to your employees’ 401(k)s on a pre-tax basis (i.e. via a Traditional 401(k)) is more tax efficient for you and for them compared to giving them raises of an equivalent amount. Consider this example using $3,000:
A $3,000 increase in employees’ base pay would mean a net increase to them of just $2,250, assuming 25% in income taxes and FICA combined. For the company, that increase would cost $2,422.12 after FICA adjusted for a 25% income tax rate.
You contributing $3,000 to an employee’s 401(k), on the other hand, results in no FICA for both you and them. The employee receives the full benefit of that $3,000 today on a pre-tax basis, plus it has the opportunity to grow tax-free in a Traditional 401(k) until retirement. As the employer, the value of your tax deduction on that $3,000 contribution would be $750, meaning your cost is just $2,250—or 7% less than if you had provided a $3,000 salary increase.
Your plan administration fees are (usually) tax deductible
Although companies have the option of passing on their plan administration fees to employees—or splitting the tab—many employers opt to pay them entirely. In this case, these costs are typically considered a tax-deductible business expense. The result is a win-win: employees keep more funds invested in their 401(k) accounts and you reduce your company’s taxable income.
Small businesses can snag valuable three-year tax credits
Thanks to the SECURE Act of 2019, businesses with fewer than 100 employees are eligible for two kinds of valuable three-year tax credits:
- For opening a new plan—Three years of annual tax credits covering 50% of the cost to establish and administer a retirement savings plan, up to $15,000 over those three years. A new version of the SECURE Act that’s likely to pass soon would increase this credit to 100% for businesses with up to 50 employees.
- For adding eligible auto-enroll—Three years of annual tax credits worth $500 for adding an eligible auto-enroll feature to your new or existing plan.
Even more valuable than a tax deduction, a tax credit subtracts the value from the taxes you owe.
