One of the things employees get most excited about regarding retirement plans is matching contributions. While this is “free money” to the employees, it is not to the company sponsoring the plan. A lot of large companies offer matching contributions, but many small- and mid-size businesses just aren’t financially stable enough to do so.
What can you do if you want to help your employees save towards retirement, but can’t afford to promise a certain percentage every year? Make discretionary contributions.
What Is A Discretionary 401(k) Contribution?
Regarding discretionary, or nonelective, contributions, the IRS states, “If the plan document permits, the employer can make contributions other than matching contributions for participants. These contributions are made on behalf of all employees who are plan participants, including participants who choose not to contribute elective deferrals.”
Unlike a matching contribution, a discretionary one is not based on what the employee contributes. A company may make a discretionary contribution for an employee who doesn’t even contribute any of his own salary to the 401(k) plan.
Employers aren’t required to make discretionary contributions, but they have the option if permitted in the plan documents. The helpful thing about discretionary contributions is that they don’t have to be made every year, and the contribution amounts are flexible.
IRS Limits For Discretionary Contributions
There are limits, however, to how much can be contributed to an employee’s account. For the year 2017, the maximum is $54,000, which includes elective deferrals, employee contributions, employer matching and discretionary contributions. If an employee makes less than $54,000, then their annual salary is the maximum that can be contributed to their account.
These limits must be taken into consideration when deciding discretionary contributions, especially in light of non-discrimination testing and limits for highly compensated employees.
Why Are Discretionary Contributions Made?
Companies choose to make discretionary contributions for a number of reasons. Some of the more common include:
To Take Advantage Of Tax Benefits
As with all 401(k) contributions, there are tax benefits for both the employer and employee. Employer discretionary contributions are tax-deductible, making them more cost-effective than raises and bonuses, for which both the employee and employer pay taxes.
To Get Employees Involved
More employees will participate in their workplace 401(k) plan if there is a contribution match. Even if it is not guaranteed, just the possibility of a match will entice employees to make room in their budgets for retirement saving.
To Avoid A Contribution Commitment
Matching contributions are a commitment that a company makes to its employees to fund their retirement, no matter what the company itself is going through. Many businesses are not financially able to make that commitment. With discretionary contributions, a business can help out their employees financially without making any binding commitment to continue to do so.
To Reward Performance
Many employers set up a “profit sharing” plan with their 401(k). This ties the company’s financial success to an employee’s ability to receive an employer contribution. The better the company performs, the more profits there will be to share with employees. This incentivizes employee performance and can be a very strong motivator.
Discretionary 401(k) contributions can be a powerful tool for businesses. They provide a way to reward and motivate employees while allowing flexibility for the plan sponsor. If you would like to know more about discretionary contributions and how your company can leverage their power, give us a call at (312) 973-4911 or email info@planpilot.com. We can show you how to take care of your employees without risking your business’s financial stability.