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How Small Businesses Can Lower Taxes with a 401(k) Plan
Tax Benefits of Starting a 401(k) Plan
June 6, 2011
As a small business owner, are you looking for ways to lower taxes? Have you considered a 401(k) retirement plan?
401(k) retirement plans offer great benefits for the business as well as its employees. With high contribution limits, tax credits, and tax deductible expenses, starting a 401(k) plan can be a smart move for your business, even if you are self-employed.
Here's a rundown of the tax related benefits to starting a 401(k):
- High contribution limits allow you to exclude from taxes up to $49,000 of income. This amount includes employee maximum contributions from salary up to $16,500 (plus another $5,500 for those over 50 years old) plus employer matching or profit sharing contributions. This tax savings alone can be significant for many small businesses. Note that these limits are indexed for inflation, although they have remained consistent the past several years.
- Employer matching contributions are tax deductible expenses for your business. Your business can choose whether or not to make matching contributions, since they are optional, but it is a good way to let owners put more into their 401(k) accounts. Keep in mind that the match must apply to all employees, and not just the owners.
- Tax credits of $500 per year for the first three years of the plan can reduce the overall costs. If your business has at least one employee besides the owner, but less than 500, a tax credit of $500 is available to offset the administrative costs of the plan. Over three years, this totals $1,500.
- Profit sharing contributions to employee accounts can help small businesses manage their tax burden. Profit sharing is completely optional, meaning you can choose it during a good year but skip it during down years. Any amount of profit sharing will reduce the business income subject to tax, since it is a tax deductible expense for your business. The contribution will obviously increase both owners and employees’ accounts, which generates goodwill and possibly employee loyalty, but it is also made on a tax deferred basis, so there is no current year tax consequence to your employees.
- Offering a Roth 401(k) option can help owners and employees save on future taxes. Including a Roth 401(k) option in your retirement plan allows owners and employees to choose to make some or all of their contributions as Roth contributions, which are made with after-tax income. Years later, these amounts can be withdrawn tax-free, including earnings, when needed in retirement. Employer match contributions cannot be made to the Roth option, however.
There are other types of retirement plans available and different reasons for choosing each type of plan. Other alternatives may be better given a business’s unique circumstances. Our tax professionals would be happy to discuss the options with you to help you decide which retirement plan is the best choice for your business. Please contact our tax professionals at 877.517.6872.
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