If you have recently started a business or even if you have an established business, you may be considering setting up a tax-advantaged retirement plan for yourself and your employees. Retirement plans are a great way to defer taxes by providing a tax deduction for employer contributions to the plan and tax-deferred build-up of your investments until distribution of the retirement funds. But how do you know when a retirement plan is right for your business? Here are several factors you may consider when making the determination:
How high is your marginal tax rate?
A marginal tax rate is the amount of tax paid on your next additional dollar of income. Taxpayers in the top income tax brackets can have a marginal tax rate of close to 50%. By contributing to a retirement plan, a high income taxpayer can receive a tax deduction for the contribution and keep the retirement plan funds growing tax deferred in the plan instead of paying the amount in taxes to the IRS.
However, if your business is new, you maybe in the lower marginal tax brackets of 10 or 15%. Your business may even be showing a loss. At this time, it may be worth your time to consider whether business funds would be better in a retirement plan or to be available in the business to increase cash flow and re-invest into the growth of the business. Funds invested into a retirement plan will be subject to a 10% penalty if withdrawn before the owner reaches age 59 1/2.
Does your business have employees?
If your business has employees and you are considering a retirement plan, there are other factors to consider. Depending on the type of plan you are considering, there are discrimination rules that, on a basic level, state that if you are contributing to the plan for yourself, you must contribute for your employees as well. This is where it will be helpful to work with your advisor to weigh the tax savings for the business owner versus the additional expense of employee contributions on behalf of the employer.
Implementing a retirement plan for your business will provide your employees with a way to create their own tax savings and invest money into a tax-advantaged retirement plan. Adding this benefit in your workplace can be seen as an advantage over other employers that do not offer a retirement plan. If your business is in an industry that competes heavily for talented personnel, a retirement plan can be part of retaining qualified staff.
What amount of funds do you have available to contribute?
As I discussed earlier, once you contribute funds to a retirement plan, you are not able to withdraw those funds without penalty until you reach age 59 1/2. Therefore, you will only want to contribute money that you and your business can live without.
There are different retirement plans that are available depending upon your circumstances and needs. If you have significant funds available to contribute to a retirement plan, you can explore options such as a 401(k). This option comes with a higher contribution amount but also has higher administrative expenses for the plan.
For lower cost plans, you are able to choose between plans such as a Simple Plan or a SEP plan. Both plans are easier to administer but have their drawbacks such as the amount you are able to contribute compared to a 401(k).
Determining when to start a retirement plan and then choosing the right retirement plan for your business can be a complicated process. We can help you through this process by discussing your needs, calculating the tax savings and choosing the best plan for your business.
We believe that in order to know how to invest for a client, we must work with the client first to develop an investment strategy that matches their personal goals and objectives, using a complete menu of investment options.