17

Why do companies offer 401k (or other) retirement plans?

Let me elaborate this...

I understand that it could be part of an employee's benefits and that a retirement plan option might increase the company's value and improve employees' retention but are there any other reasons? Does the company have any return on it? Any fiscal/financial facilitation?

Nowadays I can have access to thousands of Mutual Funds and ETFs through regular discounted online brokerage companies (that sometimes are way better than the options offered in 401ks) and a Roth IRA (for the ones who qualify) is generally more advantaged that any 'k' accounts so what's the point?

Also, why a company would prefer matching someone's contributions (and given him or her additional free money) instead of just offering a simple raise?

15

I agree with the other answers that it is a benefit, but wanted to add another explanation for this:

Also, why a company would prefer matching someone's contributions (and given him or her additional free money) instead of just offering a simple raise?

In addition to a match being a benefit that is part of your total compensation, 401ks have special rules for Highly Compensated Employees. If the lower paid employees do not contribute, the "Highly Compensated Employees" do not get to take full advantage of the 401k. By offering a match, more lower paid employees will take advantage of a 401k program allowing more Highly Compensated Employees to also take advantage of the program.

12

IRA is not always an option. There are income limits for IRA, that leave many employees (those with the higher salaries, but not exactly the "riches") out of it. Same for Roth IRA, though the MAGI limits are much higher.

Also, the contribution limits on IRA are less than a third of what they are on 401(k)s (5K vs 16.5K).

Per IRS Publication 590 (page 12) the income limit (AGI) goes away if the employer doesn't provide a 401(k) or similar plan (not if you don't participate, but if the employer doesn't provide). But deduction limits don't change, it's up to $5K (or 100% of the compensation, the lesser) even if you're not covered by the employers' pension plan.

Employers are allowed to match the employees' 401(k) contributions, and this comes on top of the limits (i.e.: with the employers' matching, the employees can save more for their retirement and still have the tax benefits).

That's the law.

The companies offer the option of 401(k) because it allows employee retention (I would not work for a company without 401(k)), and it is part of the overall benefit package - it's an expense for the employer (including the matching). Why would the employer offer matching instead of a raise? Not all employers do. My current employer, for example, pays above average salaries, but doesn't offer 401K match.

Some companies have very tight control over the 401(k) accounts, and until not so long ago were allowed to force employees to invest their retirement savings in the company (see the Enron affair). It is no longer an option, but by now 401(k) is a standard in some industries, and employers cannot allow themselves not to offer it (see my position above).

  • 1
    If you have no 401(k) or similar, the IRA (income) limit goes away. – JTP - Apologise to Monica Sep 20 '11 at 12:24
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    Deductibility goes away though – duffbeer703 Sep 20 '11 at 12:52
  • @duffbeer703 - where does it go? – littleadv Sep 20 '11 at 15:29
  • @Joe - OK, added to the answer, just wanted to be sure I got you right:-) Thanks! – littleadv Sep 20 '11 at 21:04
  • I added the Pub 590 reference. A defined benefit or defined contribution pension is a different story. I try not to use "pension" when talking 401(k) accounts. To much confusion. – JTP - Apologise to Monica Sep 20 '11 at 21:10
9

Let me add another consideration to the company's side of the equation.

Not only is a 401K a tool for the company to make them competitive when recruiting employees among other companies that offer that benefit, it is also a good retention tool.

Most company's 401K plans include a vesting period of at least 3 years, sometimes more. An employee that leaves the company before they are vested in the plan will have to give up some % of the employer matched funds in the account. This gives employees incentive to stick around longer and the company reduces the risk of turnover which can be costly in terms of training and recruiting.

This also factors into the reason why employers would rather give matching on the 401K than a simple pay raise. Some of those employees are going to leave during the vesting period anyway, and when that happens the employer got the benefit of motivating (extrinsically) the employee, but in the end got to keep some of the money.

7

Stated plainly... it's a benefit. Companies are not required to offer you any compensation above paying you minimum wage. But benefits attract higher quality employees.

I think a big part of it is that it is the norm. Employees want it because of the tax benefits. Employees expect it because almost all reputable companies of any significant size offer it. You could run a great company, but if you don't offer a 401k plan, you can scare away good potential employees. It would give a bad impression the same way that not offering health insurance would.

  • Some smaller employers have 401(k) plans that don't cost them any money out of pocket. They are mediocre plans, provided by brokerages that pay for them with higher than average expenses and fees. Yet the employer still gets to list "401(k)" on their list of benefits, and employment candidates are none the wiser until they get inside the company and investigate. – stannius Oct 15 '15 at 20:13
2

One important thing that hasn't been mentioned here is that the vast majority of companies have eventually eliminated their Company provided Pension Plans and replaced it with a 401K with some degree of matching.

There is a cost advantage to doing this as companies no longer have to maintain or work to maintain a 100% vested pension plan. This takes a great burden off them. They also don't have to manage the pension/annuity that the retirement benefit entails.

  • True. And with the departure of Gross from PIMCO companies have lost faith in pension accounts. So they shift the risk of managing your retirement to you by offering a 401(k) instead of a pension plan. – Jack Swayze Sr Oct 22 '15 at 3:19
1

The company itself doesn't benefit. In most cases, it's an expense as the match that many offer is going to cost the company some percent of salary. As Mike said, it's part of the benefit package. Vacation, medical, dental, cafeteria plans (i.e. both flexible spending and dependent care accounts, not food), stock options, employee stock purchase plans, defined contribution or defined benefit pension, and the 401(k) or 403(b) for teachers. Each and all of these are what one should look at when looking at "total compensation". You allude to the lack of choices in the 401(k) compared to other accounts. Noted. And that lack of choice should be part of your decision process as to how you choose to invest for retirement. If the fess/selection is bad enough, you need to be vocal about it and request a change. Bad choices + no match, and maybe the account should be avoided, else just deposit to the match.

Note - Keith thanks for catching and fixing one typo, I just caught another.

  • Money that is invested in 401K's is not taxable. Your employer matches your tax amount when sending it in to the government. So if you put your money in a 401k then the employer also saves on thier taxes. In addition the companies get benefits from the management firm they deal with. And if you have a large corporation with business interests they can invest in their customers with their employee contributions. There are employer benefits it is not just a cost center for them. – user4127 Sep 20 '11 at 16:43
  • @Chad huh? How does the employer save on their taxes? Give me a dollar to save a quarter? Whynnot just raise my salary to a million $$? – JTP - Apologise to Monica Sep 20 '11 at 18:27
  • There is a limit to their tax savings and it is 3% of gross pay. The employer can reduce the amount of the employer paid payroll tax liability by contributing to employee 401k. They are already paying you X. when they pay you X you pay your taxes on that the employer also has about 27% tax on it. They can reduce this by 3% by matching your contribution at 50% if they match at 100% they can still only deduct 50% up to 3% of your gross pay. – user4127 Sep 20 '11 at 18:49
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    @Chad FICA payroll taxes (the kind that are matched by the employer) are still due on an employee's earnings, even those earmarked for contribution to a 401(k) plan. The employer gets no special tax break for 401(k) matching money, vs. regular salary paid. – Chris W. Rea Sep 20 '11 at 19:02
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    To say it even more simply--both salary and 401K matching are expenses for the employer. That money does not get taxed for the company. Both get taxed for the employee, obviously--with matching being tax deferred. – Phil Sandler Sep 20 '11 at 19:25

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