As annual 401(k) plan reviews approach, are you using all the tools in your toolbox to manage what could be challenging conversations? One idea you may not have considered is to demonstrate the potential tax advantages to employers that come from how plan expenses are paid.

Many 401(k)s are reflexively set up to pass on some plan costs to participants. And some plan sponsors may be unaware that other options exist. But paying some or all plan expenses out of company funds can have benefits for both employers and employees.

Tax savings for employers

Some out-of-pocket plan fees are tax-deductible expenses, such as recordkeeping, fiduciary services, plan administration and possibly financial professional compensation. Thanks to the SECURE and SECURE 2.0 Acts, startup plans may qualify for a tax credit of up to $5,000 on out-of-pocket plan costs for three years. For qualified startups, there’s also a tax credit on contributions that employers make on behalf of participants, which can start as high as $1,000 per participant in the first year that gradually declines over five years. If certain conditions are met, a $500, three-year tax credit for plans that include or add automatic enrollment is also available. For more details and examples, take a closer look at startup tax credits.

Potential for improved retirement outcomes

By transferring some costs to business owners, participants will have lower fees, allowing them to save more for retirement. Furthermore, in small plans, the business owner often has the largest account balance. As a result, their accounts pay a big chunk of fees from plan assets. Business owners can avoid this issue — and keep more of their retirement savings growing through the power of compounding — by paying 401(k) administration fees from company assets.

In the hypothetical example below, the employer pays $11,000 of annual plan costs out of company assets instead of them being deducted from participant account balances. Over 20 years, the employer tax deductions amount to $220,000. Because participants didn’t have to pay plan costs, that money remained in their accounts and, with growth, would have added up to an extra $543,530 after 20 years. This additional accumulation may make a meaningful difference in the quality of retirement for participants.

Tax savings for employer, increased assets for employees

Assumes $1 million in plan assets, 30 participants, $11,000 in annual plan costs and an 8% annual investment growth rate over 20 years

A win-win for sponsors and participants

Leveraging the potential tax advantages of paying 401(k) plan expenses from company funds can be a strategic approach for both employers and employees. Employers can benefit from tax deductions, while employees can enjoy lower fees and potentially increased retirement savings. As a plan’s financial professional, you also have options. Some plan professionals maintain asset-based fees while others charge a flat-dollar fee. There are many choices available. Check with your specific firm for information on billing and plan compensation guidelines.

If you are considering putting this idea into action, we can help. Download our single sheet to share with clients. You may also reach out to your Capital Group/American Funds Retirement Plan Counselor.

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