Advantages and Disadvantages: 401k plan to the Employer and Employee A 401(k) plan is a retirement account to which employee and employers contribute, on which taxes are deferred until withdrawal, and for which the employee selects the types of investments. As with anything to do with the Internal Revenue Service, the 401(k) plan has many ups and downs and many regulations that must be followed. This makes things more difficult for both the employer and employee in making decisions about the plan.
We have taken a look at the advantages and disadvantages of the plan from both sides of the table to show what all is involved in deciding to use a 401(k) plan. First, we take a look at the advantages to the employers to see if it is worth it for them to offer this plan to their employees. The low cost of the plan makes it very desirable. No employer contributions are necessary because the plan can be entirely funded with contributions from your employees’ salaries. Companies do not have to offer any vesting options, unless they want to.
If they believe that the employee does not find vesting to be that important, then the employer can just basically set up the plan for their workers and that alone gives the employee a since of convenience. Many employers’ set up 401(k) plans because they are popular and offering one may help them attract and retain good employees. Many college students today are more familiar with retirement plans and may chose to work for a company based on benefits the company may offer.
A 401(k) plan could bring these college students to an employer, so it is very important for employers to think about the effects of a retirement plan such as the 401(k) when considering hiring employees. Newman, Page 2 Also, by offering vesting to their employees for each year that they work, there could be increased company loyalty. This could make workers stay at a company longer and decrease the turnover rate. A case in point is a regional restaurant chain with more than 40 locations, with each location employing more than 100 people.
After instituting a modest 20 percent matching 401(k) plan, employee loyalty and longevity increased substantially. The reduction in employee turnover was especially crucial during peak seasons when extra help was needed. The owner says the 401(k) cost is substantially less costly than employee turnover costs (www. restaurantreport. com). That is why it is important to consider providing retirement benefits to part-time and full-time employees. This will help to ensure that a pool of trained, reliable workers will be eager to return to your company whenever you require extra staff. 01(k) plans can also increase productivity. A retirement plan can improve morale, leading to more willing employees. This gives the workers a sense of security when they know that they are working to make money now and for the future. It makes the company look “more caring” to their employees, which always can make a big difference in how dedicated someone is to their work (www. 401krolloverservices. com) A 401(k) plan also has the advantage of having optional employer contributions. The employer can contribute to the plan through matching or profit sharing contributions.
A profit sharing plan is when profits are paid directly to employees in cash, check or stock as soon as profits are determined. It has a plan established and maintained by an employer to provide for the participation in its profits by its employees or their beneficiaries. Company contributions may be determined either by a fixed formula or at the discretion of the board of directors. A matching profit sharing plan designed to provide benefits upon retirement are based strictly upon the sum Newman, Page 3 otal of the contributions made and the investment results therein. The plan must provide a definite predetermined formula for allocating contributions made to the plan participants. The optional employer matching contributions or profit sharing contributions also reduce the company’s tax liability. When you have a choice, it is better to save money within a tax-advantaged retirement plan, compared to outside of one. IRAs, 401(k),s 403(b),s and other employer-sponsored plans are all considered tax-advantaged by the Internal Revenue Service.
All contributions grow tax-deferred until they are withdrawn, which means that money will grow faster than in a currently taxable investment earning the same rate of return. If you need your retirement assets now, and are prepared to pay the tax bill that result’s, you may ask your employer to pay them to you in a check. However, before you do ask for a check, you may want to compare the impact of paying taxes today versus continuing to defer taxes (www. psca. rg) Automatic payroll deductions make it easy to build a retirement nest egg with affordable deductions. 401(k)s make saving convenient because the money comes directly out of your paycheck before you ever see it. This helps you make saving a priority. Also you do not see the money so you are not tempted to spend it. If you make bad choices when compared to the competition, you make yourself less attractive to potential talent. Record keeping can be a very big disadvantage to an employer offering the 401(k) plan.
The cost can become very high and requires the organization to hire new employees to handle this job, not to mention that if they mess up somewhere it could cause many problems. They might lose some of the employee’s money, or give them more than they should have. The problems that could occur are endless. Another similar disadvantage that is related to record keeping is you must perform a yearly non-discrimination test. This test is run to make sure that your 401(k) plan does not discriminate in Newman, Page 4 any way at all.
There are also some disadvantages to the employee. These disadvantages must be looked over before deciding whether or not to take part in investing in a 401(k) plan. For the most part, 401(k) plans are relatively safe, unfortunately, they are not backed by any insurance, and that means the contributing employee could ultimately lose all their 401(k) holdings. This, however, is very unlikely considering that most 401(k)s are diversified. By diversity, one is referring to the number of different holdings within the 401(k) that are required.
The Federal government requires that employers’ give all employees at least three choices in which they can invest, not including the company for which they work. Thus, most 401(k)s are safe, unless an investor/employee has contributed an extensive amount to one particular company. Say for instance that the employee has contributed a large part of his or her savings towards the company in which they work. If that company happens to go bankrupt, or fail, that employee has lost a large portion of his/her retirement.
In a worse case scenario, like the one mentioned above, one might be a little hesitant when it comes to investing in a 401(k) plan. However, one has to also consider that nearly every money market has its own similar risk. The important thing to remember when investing, diversify among investments. Financial investors recommend investing in stocks, bonds, and T-bills. Thus the employee, in cases similar to the one mentioned above, has something to fall back on (Pink, 93).
Another disadvantage to 401(k) is the employee’s inability to spend the money they have invested in the plan. Money can be withdrawn from the account, but one must have a hardship to make a withdrawal (i. e. , a death of spouse, or on the verge of losing one’s home). The reason one considers this to be a disadvantage is because of the investors inability to have full control over Newman, Page 5 his or her investments. This is compared to an employee who opted not to invest in a 401(k), but rather to take it upon him or herself to invest in stocks and bond.
By doing so, that individual could have access to that money at any point in time, as compared to only being able to withdraw money from a 401(k) at the age of 59 and ?, or in cause of hardship (www. 401k. com). For the most part, the disadvantages are relatively insignificant if one is comparing it to all the advantages. For most employees, the need to withdraw money from their retirement plan is none existent. If money is needed, one can always borrow money and pay it back at a later time. However, the employee should seriously consider the scenario of a company going bankrupt.
Take Enron for example, many of the employees who had worked for Enron for 20 or more years, and were at or near retirement age have lost all, if not most, of the money they had invested in their 401(k). Now instead of living off of the money they and Enron had invested into their 401(k) plan, many people will have to start over. If one finds it difficult to determine whether to invest in a company’s 401(k) plan, or to take it upon him or herself to set up their own retirement package, that is because each individual employee has different needs and expectations.
The decision to choose can be become even more difficult if that individual’s company offers matching contributions. In a situation such as this, the employee will have to determine what is better for him or herself in the long run. Investing money in a 401(k) will not harm ones assets if one remembers to diversify and not rely solely on their 401(k) contribution for retirement. In doing so, the disadvantages to employees are greatly reduced, thus making the disadvantages insignificant, as compared to the enormous advantages.