Business owners can defer income tax today by saving for the future. By setting aside earnings in retirement plans such as a 401K, IRA, or SEP IRA, you can reduce your taxable income for 2019. Plus, because retirement plans are protected from creditors, you are also creating a safety net not vulnerable to business risk. Factors to consider in retirement planning include:
- Cash flow: Putting away the maximum allowable amount into retirement accounts has the greatest tax advantage. In 2019, the wage deferral limit for a 401(k) is $19,000. The 2019 catch-up deferral is $6,000 for people 50 and over, for a total deferral of $25,000. Profit sharing is also available to business owners, the 2019 maximum is $56,000 with an additional $6,000 for catch-up if over 50 years old.
This strategy works well when cash flow is strong. However, when cash flow is a challenge, your accountant can help you calibrate optimal savings without compromising daily operations.
- Employee retention: Funding employee retirement plans is a powerful retention strategy that also helps reduce the employer’s taxable income. Consider a Safe Harbor 401(k) plan. An employer match allows you to avoid most annual compliance tests, while allowing highly-compensated employees, including business owners, to contribute the maximum.
- Paying tax now or later: 401(k) plans and IRAs help reduce your taxable income for 2019. Roth IRAs have no up-front tax break, but they let your contributions and earnings grow tax-free. Roth IRA contributions are available up to a certain income level (less than $122,000 for single and $193,000 for married filing jointly.)
If your income is higher than the limit, you may want to consider a backdoor Roth IRA, which lets you convert a traditional IRA into a Roth IRA. Your accountant can advise you whether you are better served with a tax break in 2019 or in the future as your savings grow.