|I recently met with two owners of a manufacturing business, who were each contributing approximately $30,000 into their company’s 401(k) plan. They indicated one of the main reasons for setting up their company’s retirement plan was to fund their own retirement on a tax favored basis. Although the owners were each saving almost $10,000 annually in taxes, federal pension laws required them to contribute about $30,000 per year on behalf of their employees to maximize their own contributions. Therefore, they were paying more to their employees than they were saving in taxes.
When the owners reach retirement age and start taking income, they will have no idea how much they are going to owe to the government; it will be dependent upon the prevailing tax rates at the time. Due to the 2017 tax law changes, these business owners, as well as many others, are now in a reduced bracket for at least the next several years.
401(k) plans and profit-sharing plans can be a nice employee benefit. However, for many business owners, non-qualified retirement plans may provide a bigger overall tax benefit than traditional qualified retirement plans such as a 401(k) or profit sharing plan. In fact, approximately 72 percent of Fortune 500 companies use non-qualified plans as a way to compensate their executives and highly paid employees*.
Non-qualified plans don’t provide a tax deduction on contributions, but they can be designed to grow tax-free and provide tax-free income. These plans have no contribution limits and no discrimination testing. This means business owners and other high income earners can create these plans just for themselves without having to fund them for any employees. Since tax rates are currently low and will likely rise in the future, it is probably wise to pay taxes now at low rates and have nontaxable income during retirement when rates may be much higher.
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