My employers "401(k) contribution" is cash, not an actual retirement account. What are my options?

Question

I just took a job that I like, and the line in the offer letter turns out to be misleading (I think through inexperience, not manipulation).

This is it:

You will eligible to receive a 401(k) match of 6 % of base salary per annum

This led me to believe there is an actual 401(k) offered, but there isn't. When I clarified the point (after taking the job). They say:

We do not offer a 401(k). You have to set up your own retirement account but we will give you 6% gross (taxes then will be withheld, you will receive a net amount) of your earned salary at the end of the year.

I already have a Roth and Trad IRA, and I wonder if this "401(k) contribution" cash amount can only be used to contribute to those? Or because I'm employed is there another type of personal taxed-advantaged retirement account available to me?

This would be ideal, because in my understanding, the more tax-advantaged savings accounts, the better.

Another interesting consideration is that the 6% matching will be more than my individual limit for my IRAs (would prefer not to say how much). Would this amount of "cash" actually exceed the amount my employer would be able to contribute to a 401(k) (if they had one).

Trying to figure out if this arrangement is actually better or worse than having a 401(k) offered.

Answer 1

Based solely on the quote you posted, it sounds like they are just giving you a 6% "bonus" at the end of the year instead of a 401(k) match. Maybe they intended to set up a 401(k) plan but decided not to for whatever reason.

The fact they take taxes out ("you will receive a net amount") strongly indicates that this is just cash compensation and has no ties to any tax-advantaged retirement plan. You would be responsible for putting the cash into a retirement plan, subject to the contribution limits applicable to you. You would then receive a tax deduction at the end of the year.

Or you could spend it on whatever you want - I see nothing that requires you to put it towards retirement.

Trying to figure out if this arrangement is actually better or worse than having a 401k offered.

If you want to contribute to retirement above the IRA limits, then this is a bad deal*. It would not be considered a "401(k) contribution" and you would be subject to whatever limits apply to you.

Another option would be to contribute it to a Roth IRA, which has future tax benefits, meaning if your tax rate is higher when you withdraw from it you'll pay less tax then if you had contributed more to a tax-deferred IRA today.

Or take advantage of other tax-deferred accounts like an HSA or ESA.

The main point is that this 6% is like any other income - any tax planning you want to to with it is the same as if it were part of your salary.

There is a lot of speculation based on very little information; I would ask these questions of your benefits/HR department and see if they give more information.

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* To be fair, it's not as good as if they had actually set up a 401(k), but it's effectively a 6% bonus so it's still a benefit to you.

Answer 2

I'd feel pretty deceived to be honest, because you are losing the tax advantage of the match. However, it's still 6% on top of your base, so take it.

Make sure you clarify with your company if you'll need to prove somehow whether you've contributed to a retirement plan, if the type matters, and if you'll need to provide them with documentation.

You can take the after tax earnings and put it into a Roth, you know that. As for whether you end up hitting the cap, well, it happened to me. Had a good Q4 and was no longer eligible. As you aren't allowed to break the law, the brokerage is required to unwind it for you and refund the money. Confirm that, of course. And it has to happen right away. But it wasn't a big deal at all.

Answer 3

This is a 6% salary bonus in lieu of a 401(k) plan. You need to compare that offer to any others you receive. If you want to maximize your tax efficient savings (a good idea when all other things are equal but they never are), this will reduce what you can save tax efficiently because the 401(k) limits are higher than the IRA limits.

On the other hand, if you want some money in large cap US like the S&P 500 you can buy an index fund in a taxable account. It pays dividends that you have to pay taxes on as you go, but you hope a lot of the return is in capital appreciation that you don't pay taxes on until you sell it. When you sell it you pay taxes at long term capital gains rates, not ordinary income like an IRA or 401(k). For now, that is lower, but who knows what the future holds?

It sounds to me like you understand what the offer is even if the words they wrap around it are misleading. They want to pretend it is like a 401(k) match you might get from other offers. You are only talking about 6% of salary. You should assess the offers you get based on your understanding of what they are and make your decision. Once you have done so, you can choose the best approach for savings based on what is offered at your employer.

Some would see this as deception and refuse to work for the company. I might think it was not central to the company, but a way to mitigate complaints from prospective hires. It is hard.

Answer 4

It's probably too late at this point, and I don't know what's normal in your field, but maybe check if they'll let you go corp-to-corp 1099 instead of w2. I'm in IT, and I had a job offer for w2 and negotiated it to 1099. This company had a 401k, but didn't do any matching, whereas I have a solo-401k already set up for side work. The only downside for us was going to be insurance, but their insurance was so much out of pocket anyway that the extra increased hourly rate from 1099 more than covered that. So with 1099, I contribute to my own 401k, I do my own matching, I'm in a "check writing 401k" so I can invest in whatever I want (real estate, in our case) and I make a little bit extra.

It does mean that you'll have to do quite a bit of extra paperwork at the end of the year, though, calculating your self-employment taxes and filing for the 401k.

Answer 5

The biggest downside of this arrangement will be contribution limits.

If you're under the normal IRA contribution limits anyway, then you're not really losing anything here. You can simply set up an IRA and put the money into it, then claim a deduction. Or put it into a Roth IRA and not claim a deduction, but not have to pay further taxes on it at withdrawal.

However, the contribution limit difference is significant for two reasons:

• Contribution limits are already higher on 401(k)s than on IRAs. It's weird and it doesn't really make any sense, but such is tax law.

• Normal employer contributions to an actual 401(k) or IRA do not count towards your personal contribution limits. That is, with a real IRA or 401(k), you can contribute up to your personal contribution limit in addition to what the employer contributes. But if the employer just gives you cash and you have to set up and contribute to your own IRA, then everything going into the IRA is subject to personal contribution limits because there isn't an actual employer contribution.

The combination of these factors will significantly limit the total amount that you can contribute to tax-advantaged retirement accounts compared to a real 401(k). For tax year 2023, the contribution limit on a normal traditional IRA is only $6,500. For a SIMPLE IRA, it's $15,500. For a 401(k), it's $22,500. Needless to say, that's already a pretty dramatic difference. But the total limit on how much can be contributed to a 401(k) plan (including both your own contributions and the employer's contributions) is $66,000!

Granted, in practice, most people will not really be able to get that much into their 401(k), as the personal deferral limit is still $22,500 and most 401(k) plans do not involve $43,500 of annual employer contributions for an average employee. But, still, there's quite a lot of difference between $22,500 + whatever your employer contributes and $6,500 total.

So, if what you personally plan to contribute plus the 6% from the employer is less than $6,500/yr, then you're not really out anything here. But if you want to contribute more than a total of $6,500 per year, then you would not be able to put the amount over $6,500 into traditional or Roth IRAs and would most likely have to end up putting it in a normal taxed investment account instead. Putting it in a normal taxed account, of course, means that you'd pay both normal income taxes on the income and capital gains taxes on the growth rather than only paying the income taxes and the growth being effectively untaxed.

It's also important to note that that $6,500 limit is the total maximum contribution for all of your Traditional or Roth IRAs. It's not $6,500 per account per year, but rather $6,500 total per year across all accounts. Having additional accounts does not change this, but rather just makes it a bit more complicated to make sure that you're staying under the total limit.