Understanding compensation - healthcare and retiral plans
- Sanjay Gupta
- Jun 2
- 5 min read
Riding in his new EV (brand undisclosed), for which Srini was able to make a substantial down payment from his last bonus, Srini now has a good understanding of his fixed and variable compensation (Click here to read blog on fixed and variable compensation),
He has now started to look more closely at the cash equivalent benefits he is eligible for.
The two he discovered are healthcare and 401K.
In addition, once he gets his next promotion, he will also be eligible for a non-qualified defined contribution plan.
Once again, he reached out to his HR leader to understand the financial impact of these three cash equivalent benefits.
Health insurance
In March 2024, medical benefits were available to 72% of private sector workers like Srini, and 89% of state and local government workers. (2)
Dental benefits, 43% private sector and 60% state and local (2)
Vision benefits, 28% private sector and 39% state and local. (2)
For single person plans, private sector employers covered 80% of the premium and 68% for family coverage. (2)
With health plan costs touching $24000 a year for a family of four, a 68% employer contribution is $16320 – a substantial amount.
This employer and employee contributions are also exempt from federal and state taxes for the employee.
The median family income in the USA was $80,610 in 2023 (3).
For a family making $80610 and at a 17% combined tax rate, the $16320 employer contribution is equivalent to $16320 / 0.83 = $ $19662 in pretax $’s. This is a $19662 / $80610 = 24% boost in pre- tax income for this family.
Even for households in the 90% percentile of earnings at $234,900 a year in 2023 (3) and at a tax rate of 24% federal and 5% state, a $16320 in pre-tax equivalent healthcare benefit adds (16320 / 0.71) / 234900) = 9.7% to pre-tax income.
For Srini, his employer offered healthcare benefit is a double-digit % boost to his income.
He now understands why loss of healthcare coverage is considered a substantial financial hit when losing a job.
Retiral plans
In March 2024, 72% of private sector workers and 92% of those working in state and local government had access to a retiral plan (4).
Retiral plans come in two forms, defined benefit and defined contribution.
Defined benefit plans
Defined benefit plans guarantee an income to employees on retirement or after a defined number of years of working. These are also known as pension plans.
10% of private sector workers and 75% of those working in state and local government participated in a defined benefit plan in 2023 (4).
A typical pension plan will pay a defined $ value based on a formula which takes into account years of service, the average of the past 3 or 5 years of compensation, and a multiplier, typically 2% (5)
Using this formula, for someone with a last 3-year average of $80000 in compensation and 35 years of service, the defined annual benefit or pension will be $80000 x 35 x 2% = $56000
Trivia fact. Social security is a defined benefit plan or pension plan.
Defined contribution plan
In a defined contribution plan, the employee and employer contribute and at a certain age the employee has access to these funds.
70% of private sector workers and 39% of those working in state and local government had access to a defined contribution plan in 2024 (4)
The 401K and 403(b) plans are the best known defined contribution plans.
401K plans are prevalent in the for profit private sector, and the 403(b) in the not for profit.
In 2024, employees could contribute $23,000 in pre-tax dollars into their 401K or 403(b) plan, Those over 50 years of age, an additional $7000.
98% of employers offering 401K plans also contributed to them in 2022 (6), boosting the employee’s overall savings. The most typical match in 2024 was 4.6% of employee wages (7).
From his first payroll, Srini has contributed 10% of his pre-tax salary regularly to a 401K plan.
His employer adds another 3%.
Both employee contribution and employer match are non taxable at time of contribution.
At his average combined income tax rate of 27%, the 3% employer match is a (3/0.73) = 4.1% boost to Srini’s pre tax cash compensation.
When he started with the employer, Srini was putting $10,000 into his 401K every year, and today he manages to save $18,000. The employer adds another $5400
If he maintains his annual 401K contribution at the current level of $18000 + $5400 match = $23400, it will add up to some serious savings over time.
Non-qualified - Deferred compensation plans
Deferred income plans are a means of sheltering current income from taxes and paying it out at a future date, when income and taxes could be lower.
The 401K and 403(b) are forms of a deferred compensation plan. They are governed by government legislation, need to confirm to the ERISA regulations, and have a penalty of 10% for withdrawals before the age of 50 ½
.
Aside of these regulated plans, an employer can set up a deferred compensation plan of its own. These are referred to as non-qualified plans.
A non-qualified plan is an agreement between an employer and employee to take a portion of current compensation pre-tax, put it into an investment vehicle, and pay out the proceeds when the employee retires or leaves the employment.
There is no ceiling on how much income can be deferred.
Since these plans are often offered in addition to a 401K, they benefit those employees who have sufficient income to fully fund a 401K and then also want to defer more using a non-qualified deferral plan.
For those who can participate, these plans offer a means of saving on taxes by deferring income from when the employee is at peak earnings (and taxes) to a future when income and taxes are lower.
When he gets his next promotion. Srini plans to assess if he will have additional savings which he could put into the non-qualified deferral.
In closing
Digging into his benefits plan, Srini discovered that the employee sponsored healthcare and 401K plans both boost his cash compensation.
In his case the subsidized family healthcare and the 3% 401K match together boost pretax income by over 15%
For his colleagues in the $80,000 – 100,000 annual income range, the benefit is even greater - 25+% of cash compensation.
Keep swinging!
References
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