How can a 401k plan help you reduce your business taxes? If you're a business owner, why should you consider a 401k plan? Join Clayton & Wayne from Squire Wealth Advisors as they discus in Part 2 of our Business Owner series.
Clayton: So, Wayne, I think the big thing we get a lot -- and one of the main reasons people set these up in the first place -- a small business owner comes in the door, either they have employees or they don't, maybe they have a few, or maybe they have a lot, right? And they say 'it was a really good year, and we are hammered. We are totally worried about taxes this year. It's going to be astronomical, the amount we're paying in taxes.' And one of our recommendations often is, have you considered a 401(k) or a cash balance plan. Can you talk a little bit about why these plans help business owners reduce their taxes?
Wayne: Sure. So anytime you make - One of my favorite things about what I do is - When you want a tax deduction you usually have to spend a dollar to save 30 cents. Whereas with a retirement plan, the benefit there is you have to move the dollar over into an account to be saved for your retirement, but it's still your money. And you save the 30 cents or whatever tax bracket you're in. So you haven't lost it like a lot of other types of expenses. It gives somebody the ability to set some money aside for retirement and save taxes on those dollars. Later on you'll pay taxes when you withdraw it, but for most people, in retirement they're in a lower tax bracket so it works out better for them anyway. They combine that with, say, their social security. They have that supplement to their social security, some additional funds that they can live on, but they've saved more in taxes along the way than they pay in the end. Typically. We won't get into the weeds on that, but that's really the basics of why they're set up to begin with.
Clayton: That's great. I mean, that's what I love about it too, is you can have your cake and eat it too.
Wayne: Yeah, absolutely. Absolutely.
Clayton: So, who doesn't want to save and get a tax break for it?
Wayne: Yeah, it's just the same as if you bought a bunch of supplies or, you know, something like that, that you need for your business, but it's an expense, right? Once the money is spent then it's gone, whereas in this case the money isn't really spent, it's just set aside in a retirement account where it's saved for your retirement, hopefully invested and it grows and turns into a significant amount for you to have a real nest egg when you get to that point in retirement.
Clayton: That's great. So, Wayne, can you talk a little bit about cash balance plans, and what type of a business owner might benefit most from them? Because they're not a solution that's going to make sense for everybody, but there are some that can really do incredible things with them.
Wayne: Yeah, I have seen them just have tremendous amounts of tax savings for somebody. It's typically somebody in a high tax bracket, so if they have high earnings. This typically works well for a lot of the professionals out there - attorneys, doctors, dentists - but I've seen it also with sales, right? If you have a small group of employees, and specifically if you have owners that are a little older than their rank-and-file employees. And the reason for that is a cash balance plan is a type of plan where you're trying to create a sum of money to be used then for someone's retirement. So if you're closer to retirement, a lot more dollars could go in for, say, the owner, than needs to go in for the average of the other employees. So it's a great way to get past the limits. For example, a 401(k) plan has a limit. Even if you're over 50 like I am, your limit is $30,000 a year that you can contribute, maybe plus the matching contribution that a company might put in as well. But with a cash balance plan, I've seen them where even with a few employees they can put in 2, 3, $400,000. And it all depends on how much they need to replace their compensation that they're earning in retirement, and how many years they have to get that money in there. So you can really put a lot of money if you have some high-earning years and you're maybe a little bit behind on your retirement savings, it's a great way to put that money in, save on the taxes, and then have a plan where down the road you can use that money in your retirement. So they're really great for some real heavy lifting, so to speak, in your retirement funding toward the end of your career, is where I probably see them most useful.
Clayton: I like that. Just to add a point to that, I mean, we see it a lot with these professionals because they make good money and they're maxing out their 401(k)s and they're asking 'what more can I do? $22,500 isn't enough.' I've seen people put $200,000 -$300,000 combined into these plans and all of that is deductible to the business.