The tax laws are long and complicated, but they also provide many tax breaks that ordinary people can use to their advantage. The problem with many of these breaks, however, is that employers have to agree to provide them. 401(k), 403(b), and 457 plans for retirement and cafeteria plans to save for other needs like healthcare costs offer useful advantages like tax deferral and the ability to dedicate pre-tax money toward certain needs. But unlike an IRA, which you can establish on your own, your employer is responsible for setting up cafeteria plans and employer-sponsored retirement plans like 401(k)s. By understanding just how valuable these tax savings are, you might be able to persuade your employer to provide these benefits.
What tax savings you can get from work benefits
Many workers are familiar with the benefits of 401(k) plans and similar retirement accounts. Traditional 401(k)s let you save money on a pre-tax basis and then defer taxes on income and gains throughout your career. You'll only get taxed on your 401(k) money when you withdraw it in retirement. Also, Roth 401(k)s give you an alternative to the traditional retirement plan, letting you save after-tax money but then never having to pay taxes on the income and gains -- even after you withdraw your money. By using these options effectively, you can control your taxable income to some extent, and that in turn lets you manage your tax bill.
Cafeteria plans are a little more complicated. Also known as Section 125 plans, cafeteria plans give you the chance to set money aside on a pre-tax basis for purposes other than retirement. That includes items such as flexible spending accounts, dependent care assistance, and group term life insurance coverage. Not only are cafeteria plan benefits typically exempt from income tax, but they also avoid the reach of payroll taxes for Social Security and Medicare. Only in limited circumstances can some cafeteria plan benefits get taxed for Social Security and Medicare purposes.
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How much can work benefits save you?
The tax savings for the employee from having work benefits available add up. By paying less in payroll taxes and reducing taxable income, an employee can save more while keeping the same take-home pay amount in regular paychecks.
What many employers fail to notice, however, is that they can save money by providing these benefits as well. Even if an employer offers a 401(k) matching contribution -- which they aren't required to do -- the savings from other aspects of a plan can offset those costs. The calculator below provides a closer look at these tax effects.
Editor's note: The following language is provided by CalcXML, which built the calculator below.
* Calculator is for estimation purposes only, and is not financial planning or advice. As with any tool, it is only as accurate as the assumptions it makes and the data it has, and should not be relied on as a substitute for a financial advisor or a tax professional.
To see how this works, let's start with a basic example. Say that a company has 10 employees who make $2,000 per month. Currently, each employee saves $75 in after-tax money for retirement, plus another $100 to cover other costs that a cafeteria plan could include. Employees are all in the 25% bracket. The company is considering offering a 401(k) with no match and a cafeteria plan.
If you run those numbers through the calculator, you'll see that the current take-home pay amounts to $1,347 per month, and when you take out the $175 that employees save in after-tax money, the net balance is $1,172. However, if the employer provides a retirement and cafeteria plan, employees could save $100 toward retirement and $148 toward cafeteria plan expenses and still have the same net take-home pay. That amounts to $73 in tax benefits that each employee gets to keep.
Moreover, even the employer ends up ahead. The fact that each employee saves $148 toward the cafeteria plan means that the employer doesn't have to pay the employer's share of payroll taxes on that money. That adds up to $114 per pay period across all 10 employees, and that can more than offset the costs of implementing and operating the plans as well as potentially opening the door to matching contributions down the road.
Make the case for benefits
Few employers understand that they can actually end up ahead of the game by offering simple benefits like 401(k) plans and cafeteria plans. In some cases, educating your boss could produce a win-win for employer and employees alike. That's a result that you deserve.
