As a business owner, you may be looking for ways to mitigate your annual tax bite while diversifying your retirement risk. Creating a 401(k) or other retirement plan such as a SEP or SIMPLE IRA for you and your employees can potentially solve several problems which transcend personal finance. Generally speaking, accountants who are looking for additional deductions are enthusiastic to recommend retirement plans.
Alan Friedman, CPA, and Daniel Jobe, managing director with Friedman Kannenberg & Company, are no strangers to the MI retail space. Here’s what Jobe had to say in a passing conversation on this topic:
“I think this (401k) is a very important topic to talk about to help owners diversify their retirement portfolio. Many rely on the business alone and what they will sell the business for… I think that is only half of the equation. They really need to look at all angles and the retirement plan is a good tool to use.” Daniel Jobe said it all.
Let’s begin with the “Why?” Why are 401ks and other retirement plans more important now than ever? Here’s three reasons.
Less Employer Tax. Less Employee Tax. A win-win.
For the employer, every dollar contributed to a 401(k) plan is tax deductible. This includes employer-matched contributions. To offset the cost of the plan, business owners may also receive a tax credit – that’s a dollar-for-dollar reduction of your income tax liability – of up to 50 percent of the startup costs, up to $500 a year for the first three years.
Because employers must pay the payroll tax on employee bonuses, a match to the employees’ retirement plan will put more money in the pockets of both the employer and employee when an alternative to a cash bonus is desired. For the employees, they decide if they want to participate in the 401(k) and how much they will contribute. For example, let’s say the employee earns $500 each pay period, and elects to defer 5 percent of his or her pay, so $25 is taken out and placed in the 401(k) plan. These contributions are deducted from the employee’s salary on a pre-tax basis.
This means by contributing to the 401(k), the employee is reducing their current income tax. In this example, instead of paying taxes on $500, the employee is paying taxes on $475. And more importantly, employees are saving for their own future retirement, at which time taxes are due when distributed.
Less Employer Risk Through Diversification
A common mistake small business owners make is putting all their eggs in one basket. That is, if given the choice to reinvest surplus money in the business or in a retirement or investment plan, most will choose the former. Inventory is familiar.
You can touch it, and even play it. I get it. But what about building a safety net if no one is buying guitars this quarter? Investments (taxed account) and cash can provide immediate liquidity in an emergency. What if you are five-to-10 years away from wanting to exit? The more funds you have outside of your business, the more you control the terms of your exit.
An MI retail owner shared a powerful story with me. He said that his parents’ goal was to transfer the ownership to him. He said that if his parents were only relying on the proceeds of the business sale to fund their retirement, the purchase price would have been a lot higher. Because his parents had a solid retirement investment account, they were able to create very favorable terms for their son.
Employee Retention
Human capital is the most important asset MI owners have. Attracting, training, motivating, and retaining key employees is critical to the success of your business. Providing competitive employee benefits is not an expense – it is an investment.
The term “employer matching” refers to matching the 401(k) employee contribution. For example, a match may be made on a dollar-for-dollar basis up to 3 percent of the employees’ salary. The employees look at this as free, pre-tax money and it starts adding up – and since the employer match is tax deductible, so will your tax savings.
According to QuickBooks, 40 percent of employees working for small businesses say that they would leave their current company for one that offers a better retirement package which includes a 401k plan. Add vesting – where funds become available to employees over a period of time – and you just created “golden handcuffs.”
So, the choice is clear: You and your employees can pay more to Uncle Sam, or keep more of your money, while keeping your employees happy.
Jaimie Blackman – a former music educator and retailer – is a licensed financial advisor and provides investment, retirement and succession planning services. Blackman is a frequent speaker at NAMM’s Idea Center and writes The Sound of Money, a monthly column for MMR. Visit jaimieblackman. com to request your free value-creation tools and to subscribe to Unlocking the Wealth newsletter and webinars.
