The hidden cost of a 401(k) plan

By Nick Paleveda MBA J.D. LL.M

National Pension Partners

What is it? What are the costs? The plan sponsor will soon find out when the 408(b)(2) disclosures show the costs of the mutual funds within a 401(k) plan, but what the disclosures will not show is the “hidden tax cost” of a 401(k) plan.

401(k) employee contributions

401(k) plans are “employee contributions.” The contributions to the plan will have Social Security and Medicare taxes taken out before the assets are contributed to the plan. If you add up the employee and employer cost, this becomes a 13.3 percent load.

For example, if you contribute $17,000, you will have paid 13.3 percent as employer and employee — Social Security and Medicare taxes amounting to $2,261.

412(e)(3) employer contributions

A 412(e)(3) plan is a defined benefit plan that does not have these cost. All the contributions are employer contributions and Social Security and Medicare taxes are not taken out.

If you contribute $17,000, your Social Security and Medicare taxes are giving you an "extra" $2,261 you can add to your plan. You do not have a $17,000 limit on contributions (as you do in your 401(k)), which means you can contribute $19,261 (assuming you pass the DB 415 limit, which is actuarially determined — and in most cases, you will pass).

Maybe a $100,000 mistake!

Let’s say you fund your 401(k) for 25 years at 3 percent, with $17,000. You will build up a nest egg of $619,807. However, if you fund a 412(e)(3) plan with $19,261, adding in your tax savings, you will have $702,241.

If you fund your 401(k) plan for 30 years at 3 percent, you will have $808,782. If you fund the 412(e)(3) plan for 30 years, you will have $916,350 — an increase of $107,568 in your plan.


The 412(e)(3) plan can guarantee a 3% percent return for the life of the plan using a pension annuity. The 401(k) plan guarantees … nothing … except what is in your account, which could be great or could be a disaster.

Should you gamble on your retirement?

IRS Circular 230 Disclaimer: To ensure compliance with IRS Circular 230, any U.S. federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein.