Advisor Advocate Logo: A Financial Services Blog from Nationwide
About the blog

Ways to reduce taxable income for small business owners

In 2018, most small businesses saw tremendous growth. Venture capital investment in startups swelled to the highest-ever level — nearly $150 billion going into the new year. The increased acceptance of a gig economy model — using freelancers and contract employees — has made hiring more cost-effective. And, some small business owners are taking advantage of the 20 percent qualified business income deduction from this year’s tax reform bill.

All this means owners of flourishing small businesses have more taxable income — and are probably looking for ways to lower that taxable income while providing future retirement income for themselves.

What small business owners can do to lower taxable income

Establishing a qualified plan and making pre-tax contributions to that plan can help lower current taxable income. Purchasing a qualified plan-owned deferred annuity with a living benefit can help provide retirement income that an owner can’t outlive, while also providing liquidity if needed.

Two potential small business tax savings strategies

  1. Business owners can invest in small qualified plans (with one or two participants) in which an annuity is the individual account balance vehicle for profit sharing or 401(k) plans (including Solo 401(k)s).
  2. A second scenario is to establish a defined benefit plan or other pooled plan, in which an annuity is part of the overall investments.

In either arrangement, the plan-owned annuity can be distributed in-kind (i.e. through an in-kind IRA rollover) to the participant. The participant (who is now the owner of the transferred annuity) has access to the potential gains in the contract and can take retirement income using either the living benefit rider or annuitization.

Ultimately, the goal is for the plan-owned annuity to grow while business owners are still working, so at retirement they can draw from an IRA annuity and reap the benefits of their hard work.

Please be aware that living benefits are optional and come with a cost. Excess withdrawals will reduce future guaranteed payments under the rider. In general, annuities can help provide a retirement income that an owner can’t outlive (through annuitization at no cost). Variable annuities may lose value and investing involves market risk, including possible loss of principal.