Published by Mark Ring, Managing Partner, Founding Partner, and Wealth Advisor
It may seem obvious at face value, but the primary purpose of starting a business is to make money. Many business owners manage to accomplish that task very well. However, a consequence of making a lot of money is paying a lot of taxes.
Taxes are obviously inevitable, but if you can take some of your income and redirect it appropriately into tax-sheltered retirement savings, then you may be able to reduce your tax liability. If done properly, this can help you accomplish the goal of why you started your business in the first place: you can make more money!
A Time Capsule For Taxes
There are a few different options for retirement savings that will help shelter your money from the taxman. Very commonly small business owners and sole proprietors will set up a 401(k) or an IRA for themselves.
A 401(k) works a bit like a time capsule. Let’s say for example that your self-employed business pays you an earned income of $150,000 in 2021. Instead of taking all of that $150,000 into your bank account, you decide to invest the maximum amount you can into your solo 401(k) retirement account, which is $19,500 in 2021. You essentially place that $19,500 in a time capsule for later. The government would tax you on $130,500 for this year instead of $150,000, saving you thousands in taxes this year.
Meanwhile, your $19,500 goes into the future for retirement through your 401(k) time capsule, earning compound interest until you are ready to take it out. The government will wait to tax you on the retirement money until you open that time capsule up again. Yes, you will still pay taxes, but between the interest you are earning and withdrawing later in a more preferable tax bracket, this can amount to a big financial gain.
You can also have your business put a match up to 25% of your total compensation into the 401(k). In this example, that would mean that you would put a total of $57,000 into the account in 2021. That matching contribution becomes a business expense, and you get to defer taxes for a huge amount of the earnings of your business this year.
IRA To Save The Day
An IRA is a retirement savings account that works very similarly to a 401(k), but with a few different rules. An IRA has a smaller contribution limit of $6,000 per year for people under 50 and $7,000 if you are over 50. But it also allows for late contributions, meaning that you can contribute the maximum amount for the previous year late as April 15th of the current year.
This means that if you are facing a large tax bill for last year, you can take a big chunk out and give it to yourself instead! If you haven’t maxed out your IRA and you are facing a tax bill this year, you need to contact your financial advisor and get that set up right away.
Don’t Give Your Money Away
One of the easiest ways to let your hard-earned income slip through your fingers is by not taking advantage of the many tax management strategies that are available. Business owners often give away far more than they need to simply because they don’t know what options are available to them. Here at Jacob William Advisory, we specialize in helping educate business owners on how to maximize profits by minimizing tax expenses through retirement investing.
If you are ready to sit down with an experienced financial advisor and help make sure you have a solid retirement plan in place, we would love to meet with you.
Mark Ring is a Managing Partner, Founding Partner, and Wealth Advisor at Jacob William Advisory, a wealth management firm whose sole mission is to service their clients’ needs beyond their expectations. Mark has over 30 years of industry experience and for the past decade, he has been committed to building Jacob William Advisory into one of the foremost wealth advisory firms. Mark graduated from the University of Maryland with a Bachelor of Science in Economics and spends his time outside of the office with his wife, Nancy, and his two wonderful children. He gives his time to numerous nonprofit organizations related to education and the arts, often serving as a board member. He enjoys playing tennis, golf, bicycling, cooking, and traveling. Learn more about Mark by connecting with him on LinkedIn.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor.