Massachusetts State Life Insurance Practice Exam

How does tax treatment work for employer contributions to qualified plans?

1. They are treated as taxable income for employees

2. They are tax-deductible as a business expense for employers

3. They are taxed immediately at the time of contribution

4. They are limited to 20% of the total plan assets

The correct answer is: They are tax-deductible as a business expense for employers

Employer contributions to qualified retirement plans, such as 401(k) plans, enjoy favorable tax treatment. When employers make contributions, these amounts can be deducted from their taxable income, treating the expense similarly to how other costs of doing business are handled. This tax deduction allows employers to reduce their taxable income for the year, ultimately lowering the total tax liability. The significance of this tax benefit is twofold: it incentivizes employers to provide retirement plans for their employees and supports workers in saving for retirement by allowing more money to be allocated toward those plans without immediate tax consequences. Employees benefit as well, because they do not have to pay taxes on the contributions until they withdraw funds from the plan, usually in retirement when they may be in a lower tax bracket. This explanation highlights the attractive tax treatment of employer contributions to qualified plans and underscores why those contributions are considered tax-deductible for employers, contributing to a more robust retirement savings framework for employees.