401(K): the codename every US employer should know

22/07/2016 | Posted by:

401(k) US Contribution Plan

If you’re hiring a worker in the USA you’ll need to line up a retirement offer that’s both attractive and efficient. The 401(K) plan is probably your answer…

America has a famously strong work ethic. Employees in the USA do more hours and take less time off than in almost any other country. But that level of commitment is balanced by expectations about long-term financial security. Retirement plans are a key part of any employee benefits package, and employees in the US generally expect that their contract will include provision for retirement. Currently 80% of full-time workers in the US have access to an employer sponsored retirement plan and 90% of eligible employees contribute to those plans.

 

The decline of pensions in the USA…

Employer-sponsored retirement plans traditionally came in two types:

  • defined benefit plans, or pensions in which employers guarantee a specific retirement payout (or annuity), which can be based on the employee’s salary, years of service or a number of other factors.
  • defined contribution plans, which are funded primarily by the employee, with the employer matching contributions to a certain amount.

The most significant difference between the two is that for pensions, the investment risk lies with employers, who must make sure the defined benefit amount can be paid to the retired employee. Managing this risk requires complex actuarial projections and insurance for guarantees, making the costs of administration very high. As a consequence, from 1980 to 2008, the percentage of employees receiving pension plans fell from 38% to 20%* and since then has plummeted, such that defined benefit pensions are now largely obsolete in the USA.

 

… and the rise of 401(k)

In the same time period (1980 to 2008), the number of employees participating in defined contribution plans increased from 8% to 31%*. The switch away from pensions was helped by the US Government’s introduction of a defined contribution plan known as a 401(K) — named for the section of tax code that refers to the plans.

Today 88% of US employees save for retirement through 401 (K)*. It has become the most popular retirement plan in the USA because it is affordable to administer and offers tax benefits to both employers and employees, allowing each to contribute to investments on pre-tax money. Employees pay taxes on the time of withdrawal.

 

Implications for hiring a worker in the USA

If you’re looking to employ a worker in the USA it’s important to provide a 401(K) retirement package that not only meets expectations but also incentivizes your employees to give their best. If you’re hiring higher wage earners then expectations will be correspondingly higher: 89% of the highest quartile have access to retirement plans compared with 42% for the lowest*.

The government places some restrictions on 401(K) plans. The maximum contribution for 2016 is $18,000. The most popular amount to contribute is 3% of annual salary (Profit Sharing Council of America). As an employer you must be able to show that your plans benefit employees equally, regardless of seniority. This requires an annual test, or alternatively you can choose a Safe Harbor 401(K), in which you match your employee’s contribution, dollar for dollar, up to 3%.

Get in contact today to see how Foothold America can manage a 401(K) plan for your employees along with all other benefits.

*Bureau of Labor Statistics