Qualified retirement plans aren’t just for large corporations. There are a number of compelling reasons for small businesses to consider adopting a plan now or revising your current plan.
1. Reduce current taxes
I’m sure you know that as an employer you can deduct contributions you make for the benefit of employees (up to annual limits). If you are self-employed, contributions for employees are a deductible business expense, while those for yourself are deducted from gross income on your personal return. And you may also be entitled to a tax credit of 50% of your administrative costs (up to a maximum credit of $500) each year for the first 3 years of the plan.
But the tax value of contributions has greater tax impact that a simple deduction or credit. The deduction for retirement plan contributions lowers your taxable income, which in turn, can increase your qualified business income deduction if you own a pass-through entity. Keeping your taxable income below a threshold amount ($157,500 for singles or $315,000 on joint returns) means you deduct 20% of your net earnings from your taxable income.
Strategy: To maximize your retirement plan write-offs, look at all your plan choices. For example, if you are older (and you don’t have staff), consider a defined benefit (pension) plan. This could allow for a current deduction of say $100,000 (the exact amount is an actuarial computation based on age, targeted retirement date, interest assumption, etc.), which is much greater than the write-off for a profit-sharing or other defined contribution plan.
2. Build up retirement savings
As a small business owner, it’s challenging to save money for yourself; you likely plough earnings back into the business. Using a qualified retirement plan is a structured type of savings. Once you set up the plan, making annual contributions becomes routine (assuming you continue to be profitable and can afford them). For example, if you’re a sole proprietor with no employees and you maximize contributions to a SEP each year, you’re putting away about 20% of your net earnings each year. Over time and with investment returns, you’d be astounded at how the large a nest egg you can build up.
Strategy: Build your retirement plan contributions into your monthly budget. Factor in the cost of covering employees (depending on the plan you select, you usually must contribute on their behalf). And factor in tax savings (e.g., reducing your estimated taxes accordingly).
3. Attract and retain employees
In a tight job market, you are essentially forced to offer a competitive menu of benefits to attract new employees and retain the ones you already have on the payroll. Gallup research found that a third of workers said they’d leave a job for specific perks. Retirement plans are still a perk that’s highly desirable.
Strategy: Consider offering a 401(k) plan to which you make certain employer contributions. Employees may (or should) know that this is free money to them. There are different types of 401(k) plans with automatic enrollment of employees; each has different matching contribution requirements. These automatic enrollment plans enable highly compensated employees (e.g., owners) to maximize their own contributions. The IRS explains this here.
More than half of 2018 is over, but it’s not too late to adopt a qualified retirement plan for this year. Meet with your CPA or other financial advisor to discuss your options. Then take action to achieve your goals.