401k Plans Need More Planning (Part 3 of 3)

MALVERN, Pa. - Dec. 26, 2015 - PRLog -- 401k Plans are setup for many reasons; one of them being the compensation of ownership members, key executives, and performers.  If you are under 50 years old, your 401k account can be maximized at $53k per year ($59k if you are over 50 years old).  Your maximum deferred contribution is $18k per year ($24k if you over 50 years old), not including any company match.  There is a way to use the 401k Plan to maximize the annual deferrals and Part 3 will focus on the “who” when it comes to 401k Plan compensation.  The right compensation towards your 401k Plan can make the difference to its success.

For example, if your company has a $1M profit, there are a number of things you could do with that surplus of funds.  Below is a sample list:

1.      You could distribute profits to ownership.  The ownership is entitled to their share of profits, but that would create a tax liability situation.

2.      You could reinvest some, most or all of the profits into the business for Research & Development, Marketing, Expansion, Hiring, etc.

3.      Another consideration is to take a portion of the funds. For this example let’s say you take $400k of the $1M in profit and distribute it as a bonus towards ownership and key performers’ 401ks.  Many times, companies will offer the option to take as a “bonus” towards wages, put those funds towards the 401k or a combination of both.  This does a few things:

a.       You can suggest putting their funds toward the 401k and maximize it at $53k ($59k if they are over 50).  This helps to contribute more towards retirement and the funds will grow tax free.

b.      If you distribute the $400k as a bonus to ownership members and key performers, that is $400k “less” that is taxable.  Your new taxable amount is $600k ($1M - $400k = $600k).  This is a tremendous benefit of having a 401k plan, but it is an underutilized benefit many companies do not take advantage of most years.

When you have healthy and windfall years for profit, you need to be smart about your money.  You may want to create a cash war chest for future economic downturns or use the money to expand your business through marketing and hiring.  Understanding your business cycles, economic conditions and business needs will help you determine how to properly compensate ownership and key performers.  Also, consult with your CPA on tax implications to maximize your cash surplus.  Remember, paying taxes is a good thing because it means that you are profitable, but keeping ownership and key performers happy will drive your business to the next level.