Would you rather have a $1,000 bonus, or a boost in your company’s 401k plan?
After the Senate approved a new Republican tax plan, several companies have announced they will offer bonuses or increased contributions to employees’ retirement accounts.
Last week, the payment company Visa
an increase in its 401(k) match, in an email to its employees. The company previously offered employees $2 for every $1 they contributed, up to 3% of their base pay. Now, the company will offer that benefit up to 5% of base pay.
“Tax reform in the United States will strengthen Visa’s competitive position globally and create new opportunities for Visa to invest in our business,” a spokeswoman told MarketWatch. “For this reason, Visa is actively exploring a range of options with a focus on long-term, sustainable investments versus one-time actions.”
Other companies have taken a different route to the trickle down benefits for employees, offering one-off cash bonuses instead. Several companies, including Southwest Airlines
and JetBlue Airways
have generated media coverage after deciding to give their employees $1,000 bonuses because of tax reform.
Cash bonus vs. 401(k) plans — who comes out on top?
That’s a no-brainer, said Nick Clements, the co-founder of personal finance company MagnifyMoney. Visa’s offer will far outweigh a splashy $1,000 bonus. One-time bonuses are “gimmicky,” he said, considering tax reform will continue to impact companies for the foreseeable future. An increase to the 401(k) match, on the other hand, racks up benefits for years.
For starters, employees are immediately taxed on bonuses, whereas in a 401(k), contributions can continue to grow tax-free until they’re withdrawn, said Greg McBride, chief financial analyst at the personal-finance company Bankrate. And employees might be tempted to spend a bonus immediately rather than invest it, he said.
How the 401(k) increase helps Visa employees
Clements and Tendayi Kapfidze, an economist at LendingTree, which owns MagnifyMoney, calculated what the increase would mean for a Visa employee.
• If an employee earning $100,000 a year contributes enough to get the full Visa match, under the new structure, for every $5,000 they contribute, Visa will contribute $10,000 per year.
• Under the previous 401(k) program, Visa contributed just $6,000 for employees who contributed the full match of 3%.
• So the new structure produces a gain of $4,000 per year for those who contribute the full match, with a $100,000 salary.
Those new 401(k) contributions add up after 35 years
Under the new system, an employee making $100,000 and contributing 5% (while earning Visa’s 200% match on that 5%), would end up with about $2.15 million in his or her 401(k) after 35 years, assuming her salary did not increase during that time, and an annual rate of return of 7%.
Under the previous system, an employee making $100,000 and contributing 3% (while earning Visa’s 200% match on that 3%) would end up with about $1.29 million in her 401(k) after 35 years, assuming her salary did not increase during that time, and an annual rate of return of 7%.
There’s one obvious caveat: That requires the employee to participate in the 401(k) plan in the first place, and be able to contribute the maximum, Kapfidze said.
Contributing the maximum amount is rare
And now the bad news: Just 10% of Vanguard participants maxed out their 401(k) contributions in 2016, according to an analysis by Boston College.
But 401(k) accounts are important, now that Americans can no longer depend on pensions and Social Security as they could in the past, Clements said. So if an employer offers a match to the employee’s contribution, do it, he said.
“A 401(k) match is one of the few times in life when you will be offered free money,” Clements said.