Establishing a 401(k) plan for your small business is a great way to attract top talent and increase employee retention rates by helping your workers secure their financial future. Setting up a 401(k) also offers significant small business tax advantages. Yet as a small business owner, you might not know what these advantages are or how they can help your company save money.
Startup Tax Credit
When your business sets up a retirement plan for the first time and meets certain criteria, the federal government may offer your company a $500 tax credit for each of the first three years of the plan for a total credit of $1,500. This is known as the Credit for Small Employer Pension Plan Startup Costs and is designed to cover 50% of the plan's startup expenses, including administrative costs, employee education costs and more.
According to the IRS, your company may be eligible for the credit if:
- It had 100 or fewer employees who received at least $5,000 in compensation in the previous year.
- It had at least one plan participant who was not considered a highly compensated employee (owned more than 5% of the business or earned more than $120,000).
- In the last three years, no employees received benefits from another qualified retirement plan from your company.
Matching Contributions Deduction
A company 401(k) plan not only helps your employees save for their future. It also helps your business lower its tax obligations by letting you deduct the matching contributions that you make to your workers' retirement accounts.
In 2018, the maximum an employee can contribute to his retirement account is $18,500 (not including catch up contributions for people age 50 or better), while the maximum an employer can contribute to each worker's retirement account is $36,500 (the total "all sources" maximum contribution - employer and employee combined - is $55,000).
Imagine that you have 10 employees each making $40,000 annually and contribute 3% ($1,200) to each of their retirement accounts every year. That annual $12,000 ($1,200 x 10) is tax deductible. If it takes six years for employees to fully vest, that is $72,000 to the employees and the same in deductions for your business. So not only does your company 401(k) plan demonstrate your commitment to your workers. It lets you keep more money in your company's coffers.
Tax Savings vs Plan Costs
How much your company's 401(k) plan costs depends on a variety of factors, but if you choose the right retirement plan provider, the expenses can be kept to $1,000 or less. As a business owner, you can also participate in your company's plan. This means that on top of the tax savings your company receives for offering the plan and providing matching contributions, you also receive personal tax advantages by participating.
For example, if you are 38 years old, contribute $15,000 to your personal retirement account and are in the 24% tax bracket, then you could save approximately $3,600 on your tax return. This outweighs the cost of administering your company's 401(k) by three times or more.
Even with these obvious tax benefits, many small business owners do not offer a retirement plan. Some think that the administrative tasks would be too time consuming and burdensome. Others say that retirement plans are too expensive and only for large companies.
The truth is that when done right, establishing a company retirement plan is painless and relatively affordable, even for a small business. The key is to hire the right provider firm, one that has the experience, know-how and resources to smoothly set up and administer the plan. If you are ready to help your employees save for their retirement and simultaneously help your company lower its tax burden, then it is time to talk to a small business retirement plan provider to see what it can do for you.