Whether you're interested in learning about retirement planning for yourself as a participant, for your company as a business owner or HR representative, or you've been assigned this task from your employer, this series will give you everything you need to know to reach your goal.
To begin building your knowledge of retirement planning, we have to start with the basics. First what is a 401(k) plan? A 401(k) Plan is a government program that allows you to save money for your retirement years with certain tax advantages. The 401(k) has three contribution sources you should become comfortable with:
- Employee Contributions
- Employer Matching
- Non-elective Contributions
The first way to fund a 401(k) is known as the Employee Contribution. This is the amount the employee decides to defer from their paycheck and contribute to the plan. In 2021, participants are allowed to defer up to $19,500 from their taxable compensation. There is also what's known as a Catch-up Contribution of an additional $6,500 for those participants over the age of 50 for a potential total employee contribution of $26,000 for the year 2021. These employee contributions can be claimed as a personal tax deduction to lower the participant's taxable income. This tax deduction is one of the major reasons employees participate in a 401(k) Plan.
The next contribution source is known as a Company Match. The company match is only contributed to those employees who are actively participating in the plan. Please note that companies can have various matching schedules or offer no company match at all (we'll go into this in more detail in a later entry). The company match is contributed to the employee’s account on a pre-tax basis. This contribution source is considered a business expense and, therefore, qualifies as a corporate tax deduction for the employer.
The final contribution source is known as Non-elective Contributions (also known as Profit Sharing). This is also a company contribution but it differs slightly from the company match. The non-elective contribution is given to all eligible employees regardless of whether they participate in the plan or not. Therefore, you could not be actively participating in the plan and still receive this company contribution if your employer has implemented this contribution source. Just like the company match, this contribution source is considered a business expense and, therefore, qualifies as a corporate tax deduction for the employer.
Between the employee's contributions and the employer's contributions, the participant's account can be funded with a maximum of $58,000 in 2021 (or $64,500 if over the age of 50).
We'll go deeper into the different contribution sources later but this should give you a solid foundation for how you can fund a 401(k) Plan. Next week, we'll focus on the different providers you should evaluate when setting up a new retirement plan or evaluating your current providers…
