There are a number of benefits to setting up an employee retirement plan for both employers and employees. This includes the ability to attract top talent and incentivize current employees to stay with the company to maximize their benefits. However, one of the most compelling reasons employers should consider for setting up an employee benefits plan is the tax savings for both employer and employee.
Tax Benefits for the Employer
Employer contributions to qualified retirement plans are generally tax deductible. Qualified plans, like a 401(k), allow the employer to make tax-deductible contributions, up to a limited amount. In addition, qualified employers may be eligible to claim a startup cost tax credit for the plan as well as deduct the administrative fees as a business expense.
An Employee Stock Ownership Plan (ESOP) also provides significant tax benefits for employers. For example, an employer's cash contributions to an ESOP of up to 25% of qualified payroll are generally tax deductible. In addition, business owners may also be able to defer taxes on capital gains on the sale of stock to an ESOP.
Let's not forget about business owners. When a business owner is also a participant in the employee retirement plan, they can take advantage of the same tax benefits that other employees see. Thus, business owners may also be able to invest in their retirement through a plan set up for employees.
Tax Benefits for the Employees
One of the most important benefits of a retirement plan is the ability to defer taxes. The ability to defer taxes on the returns of an investment benefits employees in two different ways. First, employees benefit from tax-free growth. As an alternative to paying tax on the current returns of an investment, taxes are paid only at a future date, allowing the investment to grow without any current tax implications. Second, when the employee receives the income at retirement, the tax paid on the income will likely be at a lower rate compared to the time when the contributions were made.
Qualified retirement plans may allow employees to make pre-tax contributions to their retirement plan. Plans such as a 401(k), 403(b), or SIMPLE IRA may allow an employee to make elective deferral contributions pre-tax. Again, the employee will only have to pay tax on their contributions when taking money out of the plan.
Alternatively, depending on the employee's tax situation, they may determine a Roth contribution would be more advantageous from a tax perspective. This allows an employee to pay tax on the contribution up front but take their qualifying distributions tax-free at retirement. This may be allowed under some 401(k), 403(b), or 457(b) plans.
If you have any questions about the tax benefits and setting up an employee retirement plan for your company, the law firm of Butterfield Schechter LLP is here to help. We are San Diego County's largest law firm focusing its law practice on employee benefits law and business-tax counseling. Contact our office today with any questions on how we can help you and your business succeed.