No one likes paying taxes, but it’s a part of life. Business owners who understand how to navigate tax regulations and benefits can help reduce their tax liability. And, leveraging a defined benefit plan can accomplish two positive goals. It can serve as a valuable benefit that employees will appreciate, while also reducing the owner’s tax exposure.
First, let’s examine things from the employees’ point of view: A comprehensive retirement plan helps employees better prepare for their future, and increases their feelings of job satisfaction and loyalty. Those factors alone are often powerful incentives for business owners to establish a 401k or other type of retirement benefit plan.
The good news is, adopting the right retirement plan for employees can benefit the bottom line by reducing the owner’s tax liability. Owners also participate in the company’s retirement plan, enabling them to strategize for their future security, too.
This can be accomplished by first establishing a Profit-Sharing 401k, and then pairing it with a Defined Benefit Pension plan. Whereas other forms of retirement plans are subject to strict annual limits on contributions, this combination of benefits allows for far more contributions each year.
Because contributions to retirement plans are made on a pre-tax basis, they can effectively lower taxable income. That results in a more manageable tax bill.
The combination strategy of a Profit-Sharing 401k with a Defined Benefit Pension plan is not wise for all business owners. Some businesses, particularly younger small businesses, run on a tight profit margin. If owners are looking to save less than $57,000 annually, sticking to a traditional 401k plan might be best.
Small businesses owners with high incomes, particularly in the 37 percent tax bracket, can lower their tax liability now while stashing more money for their own retirements. Maximizing this combo strategy can save more than $55,000 in federal income taxes each year.
Those attempting to stay below the 20 percent tax break for pass-through income limits could also benefit from this plan.
And finally, those located in states that impose income taxes can also realize savings on that obligation.
Of course, tax strategies are never a simple matter. Each situation requires careful analysis in order to determine the most beneficial course of action. Contact our office to explore your options. We can help you minimize tax liability while maximizing benefits to yourself and your employees.