NEW YORK ( TheStreet) -- According to a New York Post report, "embattled" PepsiCo (PEP - Get Report) CEO Indra Nooyi is considering eliminating the company's matching contribution to employee 401K retirement accounts, as well as 4,000 layoffs.
Pepsi's employees also have a separate pension plan, independent of the 401K, according to the report, but the elimination of the match raises the question of what an employee should do if a 401K match is eliminated. Is it still worth making a tax-deferred contribution into the 401K? Is it worth avoiding the taxes?
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For starters, a matching contribution to a 401K is a wonderful thing. If, for example, your employer is willing to match half your contribution up to 3%, and your gross salary is $50,000 a year, and you contribute 6% of your salary in a year, you contribute $3,000 to the 401K and the employer contributes $1,500. That's a fat 50% immediate return on your investment for that year.
Not bad. But if the match is taken away, how much in taxes does the employee avoid if he or she continues to contribute 6% to the 401K?Even if we leave state income taxes aside, it's still worth making the contribution if you can swing it. Sticking with your scenario of an employee making $50,000 a year, if the employee is single, and leaving aside any tax deductions or tax credits, their first $8,500 in salary is taxed at a rate of 10%, their earnings from $8,500 to $34,500 are taxed at a rate of 15%, and their earnings from $34,500 to $50,000 are taxed at a rate of 25%, based on IRS tax tables. So the federal income taxes would come to $8,625. While the employee is in the 25% tax bracket, the federal income tax burden is really 17%, which is still a significant burden. So on the surface, it is still worth making the 401K contribution, and when you factor in state income tax rates, the advantage is clear. Of course, you might wish to temporarily reduce your 401K contribution in order to meet some other financial goal, such as paying down consumer debt. If you are carrying a credit card balance, you could easily be looking at a rate of 25% or more, and -- depending on your spending needs and habits -- be facing a multi-year stranglehold.
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