What is the main purpose of a salary reduction agreement?

The main purpose of a salary reduction agreement is to facilitate the deferral of income tax on salary. By entering into such an agreement, employees can choose to have a portion of their salary withheld and contributed directly to a qualifying retirement plan, such as a 401(k). This arrangement reduces their taxable income for the year since the contributions made to the retirement plan are not subject to income tax until they are withdrawn, typically during retirement.

This is a significant tax benefit for employees, as it allows them to save for retirement while postponing the associated tax liability. This strategy not only encourages retirement savings but also results in immediate tax savings for the employee at the time of contribution. Understanding this mechanism is crucial for administrators in managing and advising on retirement plans effectively.