What is a 401(k) and How Do They Work?

Value of 401(k) for Employees and Employers

Although not as wildly popular as they were a few decades ago, many employers looking to sweeten the pot for talent retention might want to consider bringing the 401(k) back. If you aren’t sure what 401(k)s are, how they work, or what benefits they provide to employees and employers, this is an explanation from our 401(k) advisor group. We think that the quiet quitting trend might have 401(k)s making a comeback.

What is a 401(k) Plan?

401(k)s are retirement savings plans that many companies used to offer as a standard perk to employees in nearly every industry. A 401(k) offers tax savings to workers who want to save for their retirement. If an employer signs up for a 401(k) retirement plan, the plan removes a portion of the employee’s paycheck directly to the account. Employees have to control the options that they want for investing, but most usually go with a mutual fund. And employers can offer additional perks by offering to “match contribute” or even contribute a percentage for the employee.

How Do 401(k)s Work?

The whole idea behind the 401(k), which was initially labeled by the IRS, is to encourage workers to save for their own retirement. In general, there are two options you can choose from, each offering different tax benefits.

Traditional 401(k)

In a traditional 401(k), the contributions made by the employees are taken from the gross income, which means that it is taken before taxes. The employee’s overall taxable income is reduced by the amount the employee contributes to the fund. That results in a tax deduction when the employee files their tax returns. You don’t have to pay on the contributed funds that you make to a traditional 401(k).

Roth 401(k)

Roth 401(k)s are not deducted before taxes; they are taken afterward, which means that the income is not deducted from the final taxes paid on year-end earnings. When the employee withdraws the money during retirement, however, no additional taxes are taken on their investment. Not all employees have the option of a Roth 401(k). If it is, workers can choose either traditional or Roth, or a combination that equals their tax-deductible contribution’s annual limit.

How Do You Contribute to a 401(k)?

The amount of money that an employee can make and an employer can match has a set limit determined by the IRS. As pensions began to fade, defined-benefit plans took over. They shifted the risk of saving for retirement to their employees. Employers are also in charge of choosing which investments within the 401(k) to select. The offers include various options of stocks, bonds, and mutual funds.

What are Contribution Limits?

Contribution limits are the amount that an employer can contribute and how much an employee can save. It is price-adjusted for inflation, which measures prices within a given economy. For 2022, the limit for employees is $20,500 per year for employees under 50 and for those over 50, an additional $6,500 is allowed.

As we head into 2023 and hard economic times, people are concerned about where the best place to put money for retirement is. A 401(k) offering might be a way for employers to provide perks to increase worker loyalty through the quiet quitting trend. At AdvantEdge HR, we still believe in the value of the 401(k) for employees and employers, and we offer a 401(k) where we take care of everything. That way, you can offer a great perk without the hassles or worry of managing the process. Contact us today to discuss how we can sweeten your talents’ pot.

More Posts

Resolve to Save for Retirement in 2023

Although there is no definitive age when saving for retirement is appropriate, you really can never start too early if you’ve done your homework about retirement planning in Charleston,