4 Qualified Plan Tax Advantages for Employers

September 28, 2020

By choosing to offer your employees a 401(k) plan, you’re sending a powerful message — that you’re invested in their future and committed to helping them work towards financial security in their retirement.

As a business owner, you can also benefit from setting up a retirement savings plan. Not only does it provide you with the opportunity to save money for your own retirement, it also enables you to take advantage of tax savings thanks to special deductions and tax credits.

Here are four ways that a 401(k) can help you reduce taxes:

#1 Personal tax benefits

Depending on the type of plan you offer, you and your employees can save for retirement in two ways:

  • Pre-tax: Contributing pre-tax dollars to the 401(k) plan while working reduces your current taxable income and allows you to defer paying taxes until you withdraw the money at retirement.
  • After-tax (Roth): If you opt for a plan with a Roth feature, you and your employees can save on an after-tax basis. While it doesn’t reduce your current tax bill, generally you can take the money out tax-free at retirement.1 This includes your contributions, along with any investment growth.

If you are considered an employee of the business, you can take advantage of these pre- or after-tax savings, too. Moreover, having a 401(k) can provide additional savings opportunities for you.

For instance, if your income exceeds the Roth limits that would prohibit you from making contributions to a Roth Individual Retirement Account or taking deductions for traditional IRA contributions, a qualified plan could eliminate these issues because contributions to a pre-tax or Roth 401(k) do not have an income ceiling.

Keep in mind that participants can save up to $19,500 in a qualified retirement plan such as a 401(k) in 2020, per IRS limits. These contributions can be split between pre-tax and Roth deferrals — much higher than the $6,000 IRA contribution limits. In addition, employees age 50 and older can make additional catch-up contributions of $6,000 to a 401(k). These maximum limits exclude any employer matching or profit-sharing contributions.2

#2 Tax-deductible employer contributions

Many employers choose to make retirement plan matching contributions, although it isn’t required. Offering an employer match can help you attract top talent, making your retirement plan more competitive and improving employee retention.

Plus, company contributions are tax-deductible as a business expense — up to certain limits, including both matching and non-elective contributions (those made directly by the employer regardless of whether or not employees contribute to the plan).

Tax laws can be favorable for business owners who offer a 401(k) or similar qualified retirement plan.

#3 Business tax credits

A qualified retirement plan is an employee benefit. Therefore, any plan-related expenses you pay may be tax-deductible, including employer contributions and the administrative costs for running the plan. These could include fees paid to a Third Party Administrator (TPA), recordkeeper, auditor or other consultants you hire to help with your plan. All of these costs can potentially be written off.

In addition, the IRS has created tax credits to incentivize small business owners to offer 401(k) plans. Employers may claim a tax credit for some of the ordinary and necessary costs of starting a qualified plan.

For 2020 and beyond, employers may qualify for a credit of at least $500. Additional credits may be available, and employers may be able to take the lesser of:

  • $250 for each non-highly-compensated employee (NHCE) eligible to participate
  • $5,000

The credit is available for the first three plan years.3

Specific criteria apply, so talk to a tax professional to understand how the credit could impact your specific situation.

#4 Increased tax savings with profit-sharing

You can further customize your 401(k) plan by adding a profit-sharing component. Profit-sharing plans offer similar tax benefits to a traditional 401(k), but they have higher contribution limits, which allow employers to enjoy additional tax savings.

With profit-sharing plans, employers contribute to employees’ retirement savings based on the company’s profitability within a given year. These plans offer employers a lot of flexibility — you can choose how much you want to contribute and even skip contributions in less-profitable years.

Profit-sharing plans provide an opportunity for you and your employees to save beyond the annual limits. For instance, employees can make salary deferrals up to $19,500 (the annual limit in 2020). However, maximum employer contributions are even higher: up to 100% of an employee’s annual salary or $57,000 per year ($63,000 including catch-up contributions for employees age 50 and older), whichever is higher. Note, combined employer and employee contributions may not exceed the $57,000 limit.

The tax laws can be favorable for business owners who offer a 401(k) or similar qualified retirement plan. It’s a great way to help you and your employees save for the future while getting tax benefits for doing so. Now is a good time to take a closer look at the options available to your business and consider how providing a competitive benefit can help attract and retain talent, save on taxes and positively impact your bottom line.

1 A Roth 401(k) offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.

2 “Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits.” Internal Revenue Service, Jan 2020.

3 “Summary of The Setting Every Community Up for Retirement Enhancement Act Of 2019 (The Secure Act).” Ways and Means. Mar 2020.

This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance or tax/legal advice. Each plan has unique requirements and you should consult your attorney or tax advisor for guidance on your specific situation.

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