Let’s start at the beginning. If you’re an employee, 401K’s are probably the best thing that will ever happen to you. The concept of being able to save money for your retirement where hopefully your company does a match is not a good thing. It’s a great thing.
But I don’t write this column for employees. This is for entrepreneurs.
Every 401K is written a little differently. Now they have hybrid plans that are 401K’s working like everything from a SEP to a KEOGH. In the interest of trying to make this reasonably understandable, let’s talk about a very generic and standard case.
We have an entrepreneur who takes a $100K W-2. He can withhold up to, let’ say, 10% with a 3% match. Let’s also assume for purposes of our case, that he withholds the maximum amount, and that his combined income tax rate is 25%.
In our sample year he withholds the $10,000 for the 401K and his company matches it with a $3,000 match. He just put away $13,000 for his retirement and didn’t have to pay taxes on any of it. The first $10,000 isn’t taxable at the federal or state level and the match was deductible at the company level. This is the best thing since sliced bread.
Or is it?
Problem #1 – He had to pay payroll taxes on $100K. At 15.3% it cost him $15,300 to save $13,000. Again, if you’re an employee it’s a great deal. It isn’t all your money. You’re going to need to pay the payroll taxes anyway. There are no choices in that regard, but our sample case is an entrepreneur. Why would anyone spend $15K to save $13K? I see it all the time, but that’s not even the bad part.
Problem #2 – 401K’s are tax deferral instruments. They happily give you a deduction today so that you can pay taxes tomorrow at the federal level. They’ll give you a pass on $13K today so that you can pay tax on maybe $30k – $50K tomorrow.
Another reason they’re happy to do this is that taxes are going up in the future rather than down.
Certainly there are variables to consider. What if your plan is written so that you can put away $20K? Would you really want to pay $15,300 to save $23,000 today just so that you could pay taxes on that plus whatever it became in the future? The income tax savings at 25% are also a variable, but you would need to save income tax on at least $71,200 for the transaction to even be revenue neutral in the short term.
If you are a larger employer, you don’t have a choice. You’re required to have a retirement plan in place, so your stuck. I just don’t want any of you acting like this is great for you. It isn’t.
Let me leave you with this.
We’re coming up to the end of the 2nd Quarter. Payroll taxes will be due next month which means that it’s time to do another round of Employee Retention Credits.
We have been incredibly successful in getting these done. Getting a check back for up to 70% of your payroll is a great thing. I’m currently handling these for over 120 entities, and I only have so much capacity. If you haven’t signed up for my Employee Retention Credit Consulting and Preparation program, please click the button located at the bottom of this communication. You’ll be glad that you did.
We’re all going to get through this. Let’s get through it together.
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