While most people may understand why a 401(k) plan is beneficial for saving for retirement, few small business owners fully understand the tax advantages they provide to the business owner. Most small business owners are more concerned with the potential cost of setting up and administering a 401(k), but they fail to see how the tax advantages can potentially outweigh the costs and actually benefit them in the long run. From tax deductions, tax reductions, and tax credits, a 401(k) can be a very valuable tool to help business owners keep more of their hard earned money and prepare for their future retirement.
- Tax savings may be greater than the cost of administering the plan for firms with less than 10 employees
In 2015, the maximum contribution into a tax-deferred 401(k) plan is $18,000 ($24,000 if you are over 50). Let’s assume you have 6 employees and you contribute the maximum amount of $18,000. If you are in a 25% tax bracket, you just saved $4,500 in taxes by making the maximum contribution. With a low-cost provider, the on-going cost of a 401(k) plan with 2-10 employees is approximately $1,200. If you subtract that cost, $1,200, from the tax savings, $4,500, the net savings to you is $3,300. Not to mention the fact that you also put $18,000 away for your retirement.
- Solo 401(k)
Solo 401(k) plans are for companies with no employees, just owners and spouses. The costs of a Solo 401(k) are much lower than the costs of a traditional 401(k). The annual fee for administering a Solo 401(k) can range from $150-$300 a year. However, the tax deferred contribution to a Solo 401(k) can be as high as $53,000 ($59,000 if over 50) and you can make that contribution for both the owner and, potentially, the owner’s spouse. That would be a combined contribution of $106,000 ($118,000 if both were over 50).
- First time buyer tax credit
If this is the first 401(k) plan that you have established for your company, you can qualify for a $500 tax credit in each of the first three years of the plan. That’s $1,500 over the first three years to help offset setup and administration charges for the maintenance of your plan. As long as your company has at least one employee, besides the owner, and the employee earns less than $120,000 a year, you qualify for the tax credit. The tax credit is equal to 50% of the administration and setup charges, up to a maximum amount of $500.
- Deductible match
While providing matching contributions to your employees is optional, most small business owners will choose to do so for these four reasons:
- Matching contributions are tax deductible for the business
- The owner benefits from the matching contribution as well since you are also an employee and you receive the match tax-deferred
- A “safe harbor” match ensures that all employees, including you the owner, can contribute the maximum amount to the plan
- By offering a small match that meets the “safe harbor” requirements, the plan avoids the hassles of government discrimination testing and ensures that everyone in the plan is served well
- Save on payroll taxes
As employees make pre-tax contributions to the 401(k) plan, their overall taxable income will be reduced. Because of this, your overall employer payroll taxes may be reduced. More tax savings. More money the employer keeps.
- Retire tax-free with a no limit Roth
If you are not as concerned with receiving a tax deduction today for your 401(k) contributions, you can direct your contributions to the Roth 401(k) option and receive income during retirement that is tax-free. In addition, while the Roth IRA is often off limits to the highly compensated due to income limitations, the Roth 401(k) does not have these income limits. Therefore, anyone in your 401(k) plan can put a portion or all of their contributions into a Roth 401(k) after-tax and receive the tax-free benefits in the future.*
- Employee loyalty and longevity
Establishing a 401(k) for your employees is a great benefit to provide for them and it shows that you care about them and their future retirement. Providing a match is an even better way to show your support for them and say “thank you” for the valuable service they provide to your company. This can create employee loyalty and, potentially, a better overall work ethic amongst your employees. In addition, if you are looking for qualified employees, offering a 401(k) and a match may be the difference in why they chose to work for your company versus your competitor. It may be just the thing that lures the talent to your organization. You can also provide incentives for staying with you company long-term. For example, you can make 1 year of service an eligibility requirement for employees to participate in the plan. You can also create a vesting schedule for matching contributions which would prevent the employee from leaving the company with 100% of your matching contributions. The vesting schedule may be 5 years until they can leave with 100% of the company match. This gives them extra incentive to stick around long-term.
*Tax free Distributions must be qualified and after 5 taxable years of participation, on or after the age of 59 ½, death or attributable to being disabled.
Christopher M. Ingram
25060 Avenue Stanford, Suite 100
Valencia, CA 91355
(661) 255-9555 Ext. 116
CA Insurance License # 0C63177
Securities and Investment Advisory Services offered through NEXT Financial Group, Inc.
Neither Next Financial Group, Inc. nor its representatives give tax or legal advice.
Please consult a professional for your specific situation.