Employer-sponsored 401(k) plans provide employees with an extraordinary opportunity to build significant nest eggs for retirement through pretax payroll deferrals. To sweeten the pot, many employers choose to make matching contributions based on a percentage of employees' pay.
A new IRS private letter ruling may make matching contributions even more attractive to employees. In the letter (PLR 202434006), the IRS says 401(k) plan participants can allocate matching contribution funds to other tax-favored accounts offered by their employers. Private letter rulings technically apply only to the parties requesting them, but they also indicate how the IRS would rule under similar circumstances. So the IRS's position here could be considered a harbinger of things to come.
Employees who choose to participate in an employer's 401(k) plan can defer part of their salaries to their plan accounts. Contribution limits are adjusted annually for inflation. For 2024, the deferral limit is $23,000, plus an additional $7,500 catch-up contribution for employees age 50 or older.
In addition, you may offer employees matching contributions up to a stated percentage of their salaries. It's common for employers to match 50% of the first 6% of salary deferred by employees, or 3% of employees' salaries. Matching contributions aren't subject to current tax.
All pretax contributions are invested in employees' accounts. Usually, employers offer a range of mutual fund and other investment options to enable participants to build diversified portfolios. Earnings within accounts are allowed to compound without current tax erosion until employees start making withdrawals (typically in retirement). At that point, distributions are taxed at ordinary income tax rates.
The recent IRS private letter ruling gave the requesting employer's workers new options. They're now allowed to make annual elections for matching contributions for the forthcoming year to be deposited in one or more of the following:
The option to contribute funds to a variety of tax-advantaged plans is generally welcomed by employees and there are typically few downsides for employers. In fact, adopting a program for matching funds could be a cost-effective decision. Assuming your company already has a 401(k) plan in place, new administrative costs would be relatively small.
However, if you don't already offer an HSA, HRA or EAP, you might incur fees to implement them. And the program will likely add some complexity to administration — particularly if you need to work with different vendors. In addition, be careful to ensure nondiscrimination requirements are met for participation in your 401(k) and any newly adopted plans.
Also keep in mind that employees will require guidance, especially those who've been relatively hands-off in 401(k) plan participation. Carefully communicate your program to workers so they fully understand it as a valuable employee benefit and know when and how to allocate matching funds.
It's important for your company to watch for new developments related to matching fund programs. In a similar scenario, Congress codified a provision on student loan debt after it was initially approved in an IRS letter ruling. But it took several years for the student loan debt provision to become law. A new matching fund program could go through the same process, but hopefully it will find a shorter, straighter path to enactment. Contact us with any questions about employee benefits.
Get in touch today and find out how we can help you meet your objectives.
