Why do some companies offer 401k retirement plans?
"I agree with the other answers that it is a benefit, but wanted to add another explanation for this: Also, why a company would prefer matching someone's contributions (and   given him or her additional free money) instead of just offering a   simple raise? In addition to a match being a benefit that is part of your total compensation, 401ks have special rules for Highly Compensated Employees.  If the lower paid employees do not contribute, the ""Highly Compensated Employees"" do not get to take full advantage of the 401k.   By offering a match, more lower paid employees will take advantage of a 401k program allowing more Highly Compensated Employees to also take advantage of the program." "IRA is not always an option. There are income limits for IRA, that leave many employees (those with the higher salaries, but not exactly the ""riches"") out of it. Same for Roth IRA, though the MAGI limits are much higher. Also, the contribution limits on IRA are more than three times less than those on 401K (5K vs 16.5K). Per IRS Publication 590 (page 12) the income limit (AGI) goes away if the employer doesn't provide a 401(k) or similar plan (not if you don't participate, but if the employer doesn't provide). But deduction limits don't change, it's up to $5K (or 100% of the compensation, the lesser) even if you're not covered by the employers' pension plan. Employers are allowed to match the employees' 401K contributions, and this comes on top of the limits (i.e.: with the employers' matching, the employees can save more for their retirement and still have the tax benefits). That's the law. The companies offer the option of 401K because it allows employee retention (I would not work for a company without 401K), and it is part of the overall benefit package - it's an expense for the employer (including the matching). Why would the employer offer matching instead of a raise? Not all employers do. My current employer, for example, pays above average salaries, but doesn't offer 401K match. Some companies have very tight control over the 401K accounts, and until not so long ago were allowed to force employees to invest their retirement savings in the company (see the Enron affair). It is no longer an option, but by now 401K is a standard in some industries, and employers cannot allow themselves not to offer it (see my position above)." Let me add another consideration to the company's side of the equation.  Not only is a 401K a tool for the company to make them competitive when recruiting employees among other companies that offer that benefit, it is also a good retention tool. Most company's 401K plans include a vesting period of at least 3 years, sometimes more. An employee that leaves the company before they are vested in the plan will have to give up some % of the employer matched funds in the account. This gives employees incentive to stick around longer and the company reduces the risk of turnover which can be costly in terms of training and recruiting. This also factors into the reason why employers would rather give matching on the 401K than a simple pay raise. Some of those employees are going to leave during the vesting period anyway, and when that happens the employer got the benefit of motivating (extrinsically) the employee, but in the end got to keep some of the money. Stated plainly... it's a benefit. Companies are not required to offer you any compensation above paying you minimum wage. But benefits attract higher quality employees.  I think a big part of it is that it is the norm. Employees want it because of the tax benefits. Employees expect it because almost all reputable companies of any significant size offer it. You could run a great company, but if you don't offer a 401k plan, you can scare away good potential employees. It would give a bad impression the same way that not offering health insurance would. "The company itself doesn't benefit. In most cases, it's an expense as the match that many offer is going to cost the company some percent of salary.  As Mike said, it's part of the benefit package. Vacation, medical, dental, cafeteria plans (i.e. both flexible spending and dependent care accounts, not food), stock options, employee stock purchase plans, defined contribution or defined benefit pension, and the 401(k) or 403(b) for teachers. Each and all of these are what one should look at when looking at ""total compensation"". You allude to the lack of choices in the 401(k) compared to other accounts. Noted. And that lack of choice should be part of your decision process as to how you choose to invest for retirement. If the fess/selection is bad enough, you need to be vocal about it and request a change. Bad choices + no match, and maybe the account should be avoided, else just deposit to the match.  Note - Keith thanks for catching and fixing one typo, I just caught another." One important thing that hasn't been mentioned here is that the vast majority of companies have eventually eliminated their Company provided Pension Plans and replaced it with a 401K with some degree of matching.  There is a cost advantage to doing this as companies no longer have to maintain or work to maintain a 100% vested pension plan.  This takes a great burden off them.  They also don't have to manage the pension/annuity that the retirement benefit entails.
Probably not. If you were at a small company and asked such a question, you'd get advice and links to erisa or other case law, etc.  it's safe to say that a Fortune 500 company such as IBM is going to have their facts in order, and not going to run afoul of the rules in these cases (vesting rules and takeover of other company).  I was in a company that cancelled its pension program. Those of us with the required years got the option of a lump sum payout, those with less than 5 years had no vested value and got nothing. One month longer employment, in the case of a particular coworker, would have given him a lump sum worth nearly 6 months pay. This question is very open ended. But I'll try to answer parts of it. An employer can offer shares as part of a compensation package. Instead of paying cash the employer can use the money to buy up shares and give them to the employees. This is done to keep employees for longer periods of time and the employer may also want to create more insider ownership for a number of reasons. Another possibility is issuance of secondary offerings that are partially given to employees. Secondary offerings often lower the price of the shares in the market and create an incentive for employees to stay until the stock price rises. All of these conditions can be stipulated, look up golden handcuffs. Usually stock gifts are only given to a few high level employees and as part of a bonus package. It is very unusual to see a mature company regularly give away large amounts of stock, as this is a frowned upon practice. Start ups often pay their employees with stock up until the company is acquired or goes public. Let me throw in one more variable to consider. Company 401K plans typically have MUCH higher fees than you are likely to get if you shop around on your own as long as you don't go with a high dollar broker. You won't see these fees on your statements typically, which I think is criminal, but they are hidden in the prices of the funds you are buying in the 401K.  If you don't believe me, get the quotes for a fund from the 401K company's web-site then look up the same fund on a site like MSMoney. The share prices won't match and you will be angry until you come to terms with it. So if you have a choice of money in a personal retirement account versus a 401K always go with your own account... UNLESS:   or "Highly Compensated Employee Rules Aim to Make 401k's Fair would be the piece that I suspect you are missing here.  I remember hearing of this rule when I worked in the US and can understand why it exists.  A key quote from the article: You wouldn't think the prospect of getting money from an employer   would be nerve-wracking. But those jittery co-workers are highly   compensated employees (HCEs) concerned that they will receive a refund   of excess 401k contributions because their plan failed its   discrimination test. A refund means they will owe more income tax for   the current tax year. Geersk (a pseudonym), who is also an HCE, is in   information services and manages the computers that process his firm's   401k plan. 401(k) - Wikipedia reference on this:  To help ensure that companies extend their 401(k) plans to low-paid   employees, an IRS rule limits the maximum deferral by the company's   ""highly compensated"" employees, based on the average deferral by the   company's non-highly compensated employees. If the less compensated   employees are allowed to save more for retirement, then the executives   are allowed to save more for retirement. This provision is enforced   via ""non-discrimination testing"". Non-discrimination testing takes the   deferral rates of ""highly compensated employees"" (HCEs) and compares   them to non-highly compensated employees (NHCEs). An HCE in 2008 is   defined as an employee with compensation of greater than $100,000 in   2007 or an employee that owned more than 5% of the business at any   time during the year or the preceding year.[13] In addition to the   $100,000 limit for determining HCEs, employers can elect to limit the   top-paid group of employees to the top 20% of employees ranked by   compensation.[13] That is for plans whose first day of the plan year   is in calendar year 2007, we look to each employee's prior year gross   compensation (also known as 'Medicare wages') and those who earned   more than $100,000 are HCEs. Most testing done now in 2009 will be for   the 2008 plan year and compare employees' 2007 plan year gross   compensation to the $100,000 threshold for 2007 to determine who is   HCE and who is a NHCE. The threshold was $110,000 in 2010 and it did   not change for 2011. The average deferral percentage (ADP) of all HCEs, as a group, can be   no more than 2 percentage points greater (or 125% of, whichever is   more) than the NHCEs, as a group. This is known as the ADP test. When   a plan fails the ADP test, it essentially has two options to come into   compliance. It can have a return of excess done to the HCEs to bring   their ADP to a lower, passing, level. Or it can process a ""qualified   non-elective contribution"" (QNEC) to some or all of the NHCEs to raise   their ADP to a passing level. The return of excess requires the plan   to send a taxable distribution to the HCEs (or reclassify regular   contributions as catch-up contributions subject to the annual catch-up   limit for those HCEs over 50) by March 15 of the year following the   failed test. A QNEC must be an immediately vested contribution. The annual contribution percentage (ACP) test is similarly performed   but also includes employer matching and employee after-tax   contributions. ACPs do not use the simple 2% threshold, and include   other provisions which can allow the plan to ""shift"" excess passing   rates from the ADP over to the ACP. A failed ACP test is likewise   addressed through return of excess, or a QNEC or qualified match   (QMAC). There are a number of ""safe harbor"" provisions that can allow a   company to be exempted from the ADP test. This includes making a ""safe   harbor"" employer contribution to employees' accounts. Safe harbor   contributions can take the form of a match (generally totaling 4% of   pay) or a non-elective profit sharing (totaling 3% of pay). Safe   harbor 401(k) contributions must be 100% vested at all times with   immediate eligibility for employees. There are other administrative   requirements within the safe harbor, such as requiring the employer to   notify all eligible employees of the opportunity to participate in the   plan, and restricting the employer from suspending participants for   any reason other than due to a hardship withdrawal." "If I understand correctly, the Traditional IRA, if you have 401k with an employer already, has the following features: Actually, #1 and #2 are characteristics of Roth IRAs, not Traditional IRAs. Only #3 is a characteristic of a Traditional IRA. Whether you have a 401(k) with your employer or not makes absolutely no difference in how your IRAs are taxed for the vast majority of people. (The rules for IRAs are different if you have a very high income, though). You're allowed to have and contribute to both kinds of accounts. (In fact, I personally have both). Traditional IRAs are tax deferred (not tax-free as people sometimes mistakenly call them - they're very different), meaning that you don't have to pay taxes on the contributions or profits you make inside the account (e.g. from dividends, interest, profits from stock you sell, etc.). Rather, you pay taxes on any money you withdraw. For Roth IRAs, the contributions are taxed, but you never have to pay taxes on the money inside the account again. That means that any money you get over and above the contributions (e.g. through interest, trading profits, dividends, etc.) are genuinely tax-free. Also, if you leave any of the money to people, they don't have to pay any taxes, either. Important point: There are no tax-free retirement accounts in the U.S. The distinction between different kinds of IRAs basically boils down to ""pay now or pay later."" Many people make expensive mistakes in their retirement strategy by not understanding that point. Please note that this applies equally to Traditional and Roth 401(k)s as well. You can have Roth 401(k)s and Traditional 401(k)s just like you can have Roth IRAs and Traditional IRAs. The same terminology and logic applies to both kinds of accounts. As far as I know, there aren't major differences tax-wise between them, with two exceptions - you're allowed to contribute more money to a 401(k) per year, and you're allowed to have a 401(k) even if you have a high income. (By way of contrast, people with very high incomes generally aren't allowed to open IRAs). A primary advantage of a Traditional IRA is that you can (in theory, at least) afford to contribute more money to it due to the tax break you're getting. Also, you can defer taxes on any profits you make (e.g. through dividends or selling stock at a profit), so you can grow your money faster." My answer is not specific, or even maybe applicable, to Microsoft. Companies don't want to cut dividends. So they have a fixed expense, but the cashflow that funds it might be quite lumpy, or cyclical, depending on the industry. Another, more general, issue is that taking on debt to retire shares is a capital allocation decision. A company needs capital to operate. This is why they went public in the first place, to raise capital. Debt is a cheaper form of capital than equity. Equity holders are last in line in a bankruptcy. Bondholders are at the front of the line. To compensate for this, equity holders require a larger return -- often called a hurdle rate. So why doesn't a company just use cheaper equity, and no debt? Some do. But consider that equity holders participate in the earnings, where bondholders just get the interest, nothing more. And because lenders don't participate in the potential upside, they introduce conditions (debt covenants) to help control their downside exposure. For a company, it's a balance, very much the same as personal finances. A reasonable amount of debt provides low-cost capital, which can be used to produce greater returns. But too much debt, and the covenants are breached, the debt is called due immediately, there's no cash to cover, and wham! bankruptcy. A useful measure, if a bit difficult to calculate, is a company's cost of capital, and the return on that capital. Cost of capital is a blended number taking both equity and debt into account. Good companies earn a return that is greater than their cost of capital. Seems obvious, but many companies don't succeed at this. In cases where this is persistent, the best move for shareholders would be for the company to dissolve and return all the capital. Unfortunately, as in the Railroad Tycoon example above, managers' incentives aren't always well aligned with shareholders, and they allocate capital in ways advantageous to themselves, and not the company. If you are working for a small company, the expense ratios on the funds in the 401k account are likely much higher than you can get with a similar IRA. Depending on your income, whether you are married and want to contribute to a spouse's IRA, your limit on what can be contributed to an IRA may vary, but the compelling reason to contribute to a 401k is that the contribution limit is higher ($17,500 vs $5,500 for people on the lower end of the income scale) so you may need to contribute to a 401k to meet your retirement savings goals. 401(k) can come in traditional and Roth forms, as can IRAs. Roth IRA money is not locked away for 40 years, only the earnings are locked away, and earnings can also be withdrawn for special cases. You might not be able to invest in an IRA if your income is too high, and if you don't get a match for your 401(k), that might not be the best option either. The biggest advantage of the 401(k) is the match (if it exists) if there's no match, the second biggest advantage is the tax deferral. If you are in a low tax bracket, that isn't as big of an advantage either. I would say that there are plenty of reasons why you might not max out the 401(k) for savings, but it's pretty easy to max out the Roth IRA if that makes more sense, so there aren't a lot of reasons why not. US corporations are allowed to automatically enter employees into a 401K plan.  A basic automatic enrollment 401(k) plan must state that employees   will be automatically enrolled in the plan unless they elect otherwise   and must specify the percentage of an employee's wages that will be   automatically deducted from each paycheck for contribution to the   plan. The document must also explain that employees have the right to   elect not to have salary deferrals withheld or to elect a different   percentage to be withheld. An eligible automatic contribution arrangement (EACA) is similar to   the basic automatic enrollment plan but has specific notice   requirements. An EACA can allow automatically enrolled participants to   withdraw their contributions within 30 to 90 days of the first   contribution. A qualified automatic contribution arrangement (QACA) is a type of   automatic enrollment 401(k) plan that automatically passes certain   kinds of annual required testing. The plan must include certain   features, such as a fixed schedule of automatic employee   contributions, employer contributions, a special vesting schedule, and   specific notice requirements. You generally have a period of time to stop the first deposit. One I saw recently gave new employees to the first paycheck after the 60 day mark to refuse to join. You also may be able to get back the first deposit if you really don't want to join. If you don't want to participate look on the corporate website or the Fidelity website to set your future contributions to 0% of your paycheck. Keep in mind several things: Personally I'm against any type of government sponsored investments or   savings. I can save money on my own and I don't care about their   benefits. Some companies provide an annual  contribution to all employees regardless of participation in the 401K. They do need to establish an account to do that. Again that is free money Does it mean if I never contribute any money so I will have 0 I might   go below 0 and owe them money in case they bankrupt or do bad   investments? Even in total market collapse the value of the 401K could never go below zero, unless the 401K was setup to allow very exotic investments. If they're not matching, and their profit-sharing has nothing to do with how much you invest, then I'd say don't bother with the company 401k at all.  If you need to at least have an account open to get the profit sharing, then contribute the bare minimum. Having your retirement account through your company forces you to follow their standards, choose from their funds, use their broker, etc.  It also means that when you leave the company, you either have to move your money anyway, or else have an account through a company you don't work for, which I wouldn't feel all that comfortable doing anyway. If you open a retirement account through your bank or a private financial planner, then it's yours, and you can contribute what you want, when you want, and buy the securities that you want.  Your account executive is there to service you, not your company. "I am failing to see why would a person get an IRA, instead of just putting the same amount of money into a mutual fund (like Vanguard) or something like that. Well, this isn't a meaningful distinction. The mutual fund may or may not be in an IRA. Similarly, the mutual fund may or may not be in a 401(k), however. So I'm going to treat your question as if it's ""why would a person get a mutual fund (like Vanguard) or something like that in an IRA, instead of just putting the same amount of money into the same mutual fund in a 401(k)."" Same mutual fund, same amount of money, narrowing your question to the difference between the two types of accounts, as stated in your question's title. Others have answered that to the extent that you really have no choice other than ""pick which type of account to use for a given bundle of money"", other than nobody having mentioned the employer match. Even if there were no other difference at all in tax treatment, it's pretty typical that 401(k) contributions will be matched by free money from the employer. No IRA can compete with that. But, that's not the only choice either: Many of us contribute to both the 401(k) and the IRA. Why? Because we can. I'm not suggesting that just-anybody can, but, if you max out the employer matching in the 401(k), or if you max out the tax-advantaged contribution limit in the 401(k), and you still have more money that you want to save in a tax-advantaged retirement account this year, you can do so. The IRA is available, it's not ""instead-of"" the 401(k)." There are a couple reasons for having a Traditional or Roth IRA in addition to a 401(k) program in general, starting with the Traditional IRA: With regards to the Roth IRA: Also, both the Traditional and Roth IRA allow you to make a $10,000 withdraw as a first time home buyer for the purposes of buying a home. This is much more difficult with the 401(k) and generally you end up having to take a loan against the 401(k) instead. So even if you can't take advantage of the tax deductions from contributions to a Traditional IRA, there are still good reasons to have one around. Unless you plan on staying with the same company for your entire career (and even if you do, they may have other plans) the Traditional IRA tends to be a much better place to park the funds from the 401(k) than just rolling them over to a new employer.  Also, don't forget that just because you can't take deductions for the income doesn't mean that you might not need the income that savings now will bring you in retirement. If you use a retirement savings calculator is it saying that you need to be saving more than your current monthly 401(k) contributions? Then odds are pretty good that you also need to be adding additional savings and an IRA is a good location to put those assets because of the other benefits that they confer. Also, some people don't have the fiscal discipline to not use the money when it isn't hard to get to (i.e. regular savings or investment account) and as such it also helps to ensure you aren't going to go and spend the money unless you really need it. I use the self-directed option for the 457b plan at my job, which basically allows me to invest in any mutual fund or ETF. We get Schwab as a broker, so the commissions are reasonable. Personally, I think it's great, because some of the funds offered by the core plan are limited. Generally, the trustees of your plan are going to limit your investment options, as participants generally make poor investment choices (even within the limited options available in a 401k) and may sue the employer after losing their savings. If I was a decision-maker in this area, there is no way I would ever sign off to allowing employees to mess around with options. "The instructions do specifically mention them, but not as exclusive plans.  Pension and annuity payments include distributions from 401(k),   403(b), and governmental 457(b) plans. The instructions also mention this: An eligible retirement plan is a governmental plan that is a qualified   trust or a section 403(a), 403(b), or 457(b) plan. 414(h) plans are ""qualified"" plans. Employee contribution to a 414(h) plan is qualified under 403(b). Report it there and mark it as ""Rollover"". Talk to a licensed (EA/CPA licensed in your state) professional when in doubt." This situation, wanting desperately to have access to an investment vehicle in a 401K, but it not being available reminds me of two suggestions some make regarding retirement investing: This allows you the maximum flexibility in your retirement investing.  I have never, in almost 30 years of 401K investing, seen a pure cash investment, is was always something that was at its core very short term bonds. The exception is one company that once you had a few thousand in the 401K, you could transfer it to a brokerage account. I have no idea if there was a way to invest in a money market fund via the brokerage, but I guess it was possible. You may have to look and see if the company running the 401K has other investment options that your employer didn't select. Or you will have to see if other 401K custodians have these types of investments. Then push for changes next year. Regarding external IRA/Roth IRA: You can buy a CD with FDIC protection from funds in an IRA/Roth IRA. My credit union with NCUA protection currently has CDs and even bump up CDs, minimum balance is $500, and the periods are from 6 months to 3 years.