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How to Use a 401(k) Plan to Lower Your Personal Taxes

02/09/2010:

With current tax regulations expected to expire in 2011, personal tax rates will rise for many small business owners. This can be a substantial hit to you. One way to help keep the taxman at bay and protect more of your money from taxes this year is to make use of the high contribution limits of a 401(k) on a pre-tax basis. If you are more concerned with future tax increases, the Roth 401(k) feature (no income limits unlike a Roth IRA) gives you an option to help manage this too.

Lowering this year’s tax bill

A 401(k) enables you to help lower your current year taxes through personal contributions of up to $16,500 pre-tax ($22,000 if you are over 50 years of age). Plus with an optional company match and/or profit sharing, you have the ability to put up to $49,000 ($54,500 if over 50) a year into your account. Self-employed owners love this option as saving $49,000 a year can drop you a tax bracket!

Lowering future taxes with a Roth 401(k)

If you want to hedge future tax consequences with the Roth 401(k), you are able to do so with your personal after-tax contributions of up to the $16,500 limit. By contributing after-tax now, your withdrawals from your Roth savings in the future will be tax-free earnings and all!

You also have the choice on how much you want to tax diversify by contributing some, all, or none of your money into the Roth option. Yes, you determine how much you want to contribute pre and/or post tax. Just know that all company matching and profit-sharing contributions are required to be on a pre-tax basis as you consider what’s right for you.

Not a bad way to keep more of your money both today and tomorrow.

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