When managing a small business, it’s important to establish a retirement plan that’s right for your business. Assessing the needs of businesses when it comes to retirement planning is a common occurrence among our clients. As our clients grow their businesses, we help them replace existing retirement plans with 401(k) plans. Usually, 401(k) retirement plans offer more flexibility than other retirement plans. Here, we’ll explore some of the key facets of these retirement plans, and the benefits that are provided to you and your business.

Benefits for New Talent

It’s difficult enough to attract talented individuals to your organization. A 401(k) may make your job offer more likely to be accepted by potential candidates. Since job seekers see a 401(k) as a more robust retirement plan, offering this as a company benefit will provide you an edge. Additionally, 401(k) plans can incentivize key talent to stay with the company by establishing plan features such as gradual vesting of company contributions.

Personal Retirement Savings

401(k) plans also provide a way to save for your own retirement as a business owner. In some cases, you can save more with a 401(k) than with an SEP or IRA. It’s important to remember however, that since a 401(k) is a Defined Contribution plan, the maximum contribution allowed by the IRS in 2020 is $57,000 annually, or $63,500 if you’re over the age of 50. To maximize contributions to a 401(k) as a business owner, it’s usually important to include a profit-sharing plan as a component of your 401(k). You can contribute to your 401(k) through a variety of ways as both an employee and the employer, as outlined below:

• 401(k) Salary Deferrals – In 2020, you can create a salary deferral of up to $19,500. Those over 50 can defer up to $26,000 in 2020.
• 401(k) Matching Contributions – Your company matched contributions can be either as a set dollar amount or a contribution match, but another common contribution type is the safe harbor contribution. This allows your company to match up to 4% of your personal contribution and is immediately 100% vested.
• Profit-sharing Contributions – Profit sharing allows your company to offer employees a share of your profits on a discretionary basis. This means that you can make the decision to make contributions to your employees annually. However, certain criteria must be met when electing to utilize profit sharing. For instance, it’s illegal to discriminate in favor of highly paid employees when electing to profit share. To encourage retention, profit sharing can be subject to a schedule.

Hypothetical Scenario

Janet has established a 401(k) and profit-sharing plan through her business for her and her employees. Janet has an annual salary of $175,000 at age 55. Her salary deferrals are maxed at $19,500, and she’s eligible for catch-up contributions. When Janet set up the 401(k), she included safe harbor matching at 4%. This way, Janet can contribute an additional $7,000 towards her 401(k) from her company’s assets. Lastly, Janet elected to profit share a contribution of $30,500 in her account, while also minimizing the profit-sharing contribution to her employees. This way, Janet was able to bring her entire contribution up to the IRS limit of $63,500.

Tax Benefits for Your Business

401(k) plans can also provide businesses with tax benefits. If a business owner over the age of 50 defers salary on a pre-tax basis, their taxable income can be reduced by as much as $26,000 in 2020. Other contributions from the employer, like profit sharing, are also tax deductible, subject to certain limits.

401(k) plans offer a variety of tax benefits to small business owners. If your business has fewer than 100 employees, you’ll receive a tax credit for 3 years when starting a 401(k) plan for the first time. Other tax credits exist for plans that automatically enroll new hires, and plan management expenses can also be tax deductible.

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