401(k) Plans for Small Business Owners

Qualified plans, such as a 401(k) plan, offer excellent benefits for small business owners. These plans can provide a multitude of tax advantages that combine to deliver far more tax leverage than most people may imagine. 

401(k) plans, named for the section of the tax code that governs them, arose during the 1980s as a supplement to pensions. Most small business owners used to offer pension funds. Pension funds were managed by small business owners and they paid out a steady income over the course of the retirement. But as the cost of running pensions escalated, small business owners started replacing them with 401ks.

Here is a list of the advantages a 401(k) plan may provide for your company:

  1. Within the limits of the present tax and ERISA (Employee Retirement Income Security Act) rules, the business receives a current income tax deduction on contributions to the plan and the individual employees are not taxed on plan contributions made on their behalf. 
  2. Improving employee benefits will provide an advantage when seeking to recruit and retain good employees. Often, a significant amount of the contribution for the employee’s benefit has been realized as a result of corporate after-tax income savings to the plan.
  3. Plan funds will accumulate on a tax-deferred basis.
  4. At retirement age, individuals are provided with favorable tax treatment on the plan distributions. They may, for example, use their interest in the plan to fund an annuity to fit their retirement needs and be taxed on the income only when received.

The Bottom Line

While an obvious advantage to a 401(k) and other qualified plans is the ability to take a deduction today and postpone paying taxes until tomorrow, it is clearly not the only advantage. Even more important is the ability to invest employee retirement funds on a tax-deferred basis. As a result, whether tax rates remain the same or increase, a 401(k) plan remains a valuable tax planning tool for small business owners.

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