Business Owners - Consider a Retirement Savings Plan to Reduce Taxes
As tax time approaches, our clients often inquire about ways to lower their tax burden. While we don’t provide tax advice and it’s best to bring one’s CPA into the discussion, we do point to one area that is often overlooked. In our view, there is no easier and quicker way to lower taxes than to contribute to a retirement savings plan. Many of us are aware of the advantages of individual retirement accounts (“IRAs”) or work 401(k)/403(b) plans. The tax benefit is obvious (i.e., contributions to the plan are removed from taxable wages). Business retirement plans generally work in the same way; however, the contribution amounts can generally be much larger.
As you probably know, retirement accounts lower your current year tax bill because they, generally, lower your taxable wages in the year of the contribution. Rules vary based on the chosen plan, the participant’s level of income and other factors, but the tax savings can be substantial. Moreover, once added to the retirement savings plan, the money grows tax-deferred throughout one’s lifetime. We’d also point out that there are other advantages of putting money into retirement plans. For example, there are circumstances where one can pull money with no penalty before retirement (e.g., certain conditions related to a first home purchase, disability or certain medical expenses). Also, there may be opportunities to provide charitable gifts from retirement accounts to avoid income taxes on withdrawals.
While the flexibility of 401(k) plans makes them popular with large companies, two of the best options for small to medium-sized business are “SEP” and “Simple” IRAs. Both plans are easy to establish and maintain while providing an opportunity to achieve better overall economic results through tax savings. In a nutshell, these tools provide an easy way to yield more money for every dollar of revenue in your business and should be considered by all business owners.
SEP stands for “Simplified Employee Pension” and was created to provide small businesses and self-employed individuals the opportunity to create retirement savings accounts. SEPs can generally be easily established through brokers (e.g., Charles Schwab) in a manner that is very similar to setting up an IRA. In fact, they have many of the same benefits as IRAs including tax-deferred growth and tax savings in the contribution year. However, SEPs can be far more advantageous than using IRAs given that they have much higher contribution limits. For example, in 2025 the contribution limit for IRAs is $7,000 per person versus a whopping $70,000 per person for a SEP. SEP contributions are based on a chosen percentage of income (up to 25%) and employers must contribute to employee accounts at the same level as business owners. So, SEPs are great tools for small closely held businesses and self-employed “1099 contractors” that have a desire to convert cash flows into retirement savings in a tax-efficient way. SEPs also have flexibility in that the contributions can be “turned on/off” from year to year based on cash availability. One of the best features of a SEP is that contributions are not required until the due date of the business return so businesses can generally assess their full-year performance after the year is over before making a final determination on contribution amounts.
A SIMPLE plan which stands for “Savings Incentive Match Plan for Employees” generally has the same tax benefits as a SEP IRA (i.e., tax deferred growth and tax savings at the time of contribution). However, SIMPLE plans are much better for medium-sized businesses with up to 100 employees that are looking to establish a plan as an employee benefit (e.g., more like a 401(k)). SIMPLE plans can be established through brokers (e.g., Charles Schwab) and are generally much easier and cheaper to administer than 401k plans. Generally, employers must either agree to “match” an employee’s contribution, up to 3% of income, or pay in 2% of income to each employee annually.
It’s worth noting that SEP and SIMPLE IRAs can be easily managed by professional advisors when established through brokers such as Charles Schwab. For example, Patina can include SEP & SIMPLE IRA accounts in the same investment models that it uses to manage individual accounts. So, while many 401k plans have limited investment options and are exclusively self-directed by the account owner, SEP/SIMPLE plans can be invested in anything available on the brokerage platform and, if desired, directed by a professional wealth advisor.
It’s worth reviewing the tax benefits of business retirement plans as they are substantial. For one, the contribution is generally tax-deductible in the year that it is made. So, as a proxy for that benefit, you can multiply your estimated tax rate by the contribution amount to compute an estimated savings (e.g., a 30% marginal tax rate with a contribution amount of $25,000 may yield an approximate savings of $7,500). Moreover, businesses do not pay “payroll taxes” on retirement contributions so business owners may see additional tax savings when wages are reduced in favor of retirement plan contributions. So, with minimal incremental work and expenditure, you can keep more of the money your business is earning. The second big benefit is that tax-deferred growth means that these plans pay no taxes on year-to-year gains. Rather, they are generally taxed as income upon withdrawal in retirement – a benefit that can be enormous when compounded over decades of growth. Also, we would point out that one’s tax rate in retirement is often much lower than during peak earnings years. We’d be happy to assess the retirement savings potential of your business so give us a call if you think it could be a fit.