As I often tell business owners, the easiest way to manage taxes is to write the IRS a big, fat check. It’s simple and it’s easy. However, it’s not necessarily the best way to realize true tax savings.

Business owners need to be smart about their tax-planning strategy and need to consider it within the context of their business retirement plan.

Designing a tax-wise, tax-efficient retirement plan requires planning, review and upkeep. These three things are easy for busy business owners to neglect — but if you stick with it, you can see advantages for yourself, your business and your employees.

To get started, I suggest assembling a team of professionals. The team might include a certified public accountant; a business financial planner; a retirement plan administrator; and an attorney specializing in the Employee Retirement Income Security Act, commonly know as ERISA.

Each team member should be familiar with your personal and professional goals. The team should help you consider needs based on your business ownership type, employee census, key employees, marital status and profitability.

Once you have a handle on your requirements, you can start looking into the benefits and drawbacks of various plans. The different plans available include 401(k); SEP IRA; IRA; profit sharing; money purchase; defined benefit; SIMPLE IRA and 401(k); or Roth 401(k).

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These plans are designed to help businesses and individuals save for retirement on a tax-deferred basis.

For most business owners in Maine, a pre-tax plan equates to a 33.5 percent savings (25 percent federal and 8.5 percent state tax brackets). Think of it this way: The federal and state governments are deferring your tax liability and giving you 33 cents for every dollar you save — not a bad rate of return.

Many times, with proper design, a retirement plan can achieve multiple objectives. You can reward employees and owners, maintain a vesting schedule to retain key staff and, of course, defer tax liability, which ultimately reduces overall tax liability for the business.

As you consider your plans, there are many questions to ask: Should the plan provide a dollar-for-dollar match to increase employee participation? Should it use 3 percent toward a Safe Harbor contribution to satisfy top-heavy testing rules for owners and key employees? Should both be used? Should the tax savings be used to reward all employees based on age and position through a profit-sharing contribution?

In short, you need to find out what’s best for you. The answer depends on a number of factors, such as your employee census, ages, vesting, salary, business entity and profitability.

Because there are so many variables, one size may not fit all. Off-the-shelf plans may work for some businesses; but such prototype plans may not reflect what’s best for you, your business or your employees.

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For example, a custom plan may integrate “paired” retirement plans, taking two plans and creating a new one based on the objectives of the owners — such as using the tax-free nature of the Roth 401(k) contributions with the tax-deferral capacity of a profit-sharing plan.

One last tip: Don’t choose a plan and just forget about it. Business owners often choose a plan and stick with it, year in and year out. The reasons are easy to understand; setting up a retirement plan takes time and money. However, it’s important to revisit your plan annually, because businesses and IRS laws evolve.

Finally, just remember that, at the end of the day, a properly formulated retirement plan has the ability to reward your thoughtful efforts.

 


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