Top Tax Reasons to Start a 401(k)

401(k) plans offer valuable tax benefits. Contributions are tax-deductible for businesses, and certain tax credits may apply (see #3 and #4 below). Traditional 401(k) contributions are tax-deferred, which means you can lower your taxable income for the current year by contributing. Additionally, any dividends, capital gains, or interest earned in the account grow tax-deferred, allowing you to build wealth over time. Taxes are only applied when funds are withdrawn during retirement^*—unless they’re held in a Roth 401(k) (see #5 below).

In 2025, you can contribute up to $23,500 into a 401(k) without paying taxes on that money now ($31,000 if you’re over 50). For example, if you’re under 50, own a business with seven employees, and contribute the full $23,500, you’ll save more on taxes this year compared to utilizing a traditional IRA which limits are much, much lower. See the example below for a detailed breakdown of the savings benefits of a 401(k):

401(k) vs IRA Deferred Tax Savings Example¹

401(k) vs IRA Deferred Tax Savings Example¹	401(k)	IRA
Maximum Allowable Contribution	401(k) $23,500	IRA $7,000
Effective Tax Rate	401(k) 25%	IRA 25%
Personal Tax Savings for This Year	401(k) $5,875	IRA $1,750
Annual Employer 401(k) Cost	401(k) - $1,140 (FYI this cost is tax deductible)	IRA N/A
Tax Deferred Savings Less Employer Admin Cost	401(k) = $4,735	IRA $1,750

¹ Assumes a business owner under 50 years of age who pays taxes at an effective tax rate of 25% and owns a business with less than 10 employees. The example illustrates the difference in personal tax savings afforded via a 401(k) versus choosing to invest the maximum in a traditional IRA. The taxes are deferred until monies are withdrawn in retirement. You may pay more or less in taxes in the future than you do today. The example shows the tax savings difference both with and without the typical ongoing administrative price associated with the Safe Harbor plan type at ShareBuilder 401k for the owner’s perspective. Note that ShareBuilder 401k plan pricing is built to automatically change based on assets and number of employees. With the same number of employees and increased assets, plan pricing will lower at preset milestones.

You could save $5,875 on taxes this year while contributing $23,500 toward your future. Offering a 401(k) match increases retirement savings for both you and your employees!

Self-employed business owners without employees can save more with a solo 401(k). This plan allows tax-deferred savings of up to $70,000 annually ($77,500 if you’re age 50+). As both the employee and employer, you can contribute $23,500 ($31,000 if you’re age 50+) as the employee and profit share tax deferred 20-25% of your income as the employer, up to the total $70,000 annual limit.

Owners and employees in non-solo 401(k) plans have the same high limits, it just can be more difficult to reach the maximum depending on how much your business is willing to contribute to all employees, the employee’s contributions and their income.

For business owners with employees, 401(k) plans offer the same high limits. However, reaching the maximum can be challenging because it depends on your business contributions for employees, how much employees contribute themselves, and their income levels. With the right 401(k) plan for you and your business, you can lower your taxable income – and maybe even your tax bracket!

There are other ways to take advantage of 401(k) tax benefits. Giving your employees a 401(k) match, profit share or other, is tax deductible for your business. Most small business owners with steady revenue choose to match for three reasons:

1. By matching, you (the owner) benefit right along with your employees since you are also an employee and thus receive the match.

2. A ‘safe harbor’ 401(k) ensures that any employee and owner can give the maximum to the plan and automatically satisfy IRS discrimination testing.

3. Since the match is deductible and eligible for tax credits, employer contributions tend to be minimal true cost for the business; however, you will want to have the cash flow to manage the contribution each payroll.

Starting a New Plan? Tax Credits will Cover 100% of the Costs

If you're starting a new 401(k) and your business has less than 100 employees, you could qualify for up to $5,000 in tax credits annually over the first three years. For companies with 1-50 employees, this covers 100% of qualified business 401(k) costs such as setup and monthly administration. For companies with 51-100 employees, this tax credit can be applied to 50% of your qualified 401(k) costs. Plus, if you add automatic enrollment, you could receive an added $500 each year for the first three years. That’s up to $16,500 in tax credits over the first three years!

Here’s How It Works:

To qualify for a tax credit, your business must have at least one employee, other than you as the owner, who earns less than $160,000 a year (a Non-Highly Compensated or NHC employee). The tax credit is the greater of the $500 or $250 per NHC employee, with a maximum of $5,000, covering 100% of the costs you incur.

For example, if you have 10 employees and your ShareBuilder 401k business cost is $1,200 annually, your tax credit in the first year would be $1,200. Over the first three years, assuming your business size and costs remain the same, your total tax credit would be $3,600. Learn more about these tax credits here.

Tax Credits for Employer Matching

Additionally, plans with 1-50 employees can qualify for tax credits of up to $1,000 per employee based on the employer match, or contributions provided to the employees. This applies to the first 50 employees who earn less than $100,000 per year. The applicable percentage is 100% in the first (year plan begins), then up to $1,000 per employee for the next year, 75% in the third year, 50% in the fourth year, 25% in the fifth year, and none for subsequent years. There are some added tax credits for employees 51-100 as well, but a lesser percentage.

Here’s How It Works:

Let’s say in year one your business contributes $15,000 to the plan and you have 10 employees who earn less than $100,000 and receive over $1,000 in employer contributions. You just qualified for $10,000 in tax credits! Continuing with this example and assuming the number of employees and contributions stay the same, you’d receive tax credits of $10,000 in year two, $7,500 in year three, $5,000 in year four, and $2,500 in year five for a total of $35,000 over five years. That’s powerful stuff!

It's important to note that for those contributions you receive a tax credit, those likely don't qualify for tax deductions. However, the amount not covered by the credit should be deductible. You'll want to review with your tax accountant.

If tax protection is not your primary concern, or you anticipate higher tax rates in the future, the Roth 401(k) is something to seriously consider. Unlike a Roth IRA, a Roth 401(k) has no income limits, allowing anyone in a 401(k) program to contribute after-tax funds. You can allocate some, part, or all your contributions after-tax into a Roth 401(k). Since these contributions have already been taxed, this money, along with any gains, is not subject to taxation when withdrawn in retirement. And better yet, as of SECURE ACT 2.0, profit-employer matching and profit-sharing contributions can be allocated to a Roth 401(k) account.

As you look for new ways to pay yourself more, protect your money, and keep taxes in check, there are many benefits of a 401(k). To maximize 401(k) tax benefits, starting early is key. Your savings could potentially last you a lifetime. Visit our products page to explore retirement plans and start saving for your future today.

^*Assets withdrawn before 59½ may incur a 10% tax penalty.

Benefits of a 401(k): Reduce Your Taxes Today and Save More for Tomorrow

Is a 401(k) Tax Deductible?

Tax Bracket Busting

401(k) Tax Deductions

401(k) Tax Credits to Offset Your Employer Plan Costs

Starting a New Plan? Tax Credits will Cover 100% of the Costs

Tax Credits for Employer Matching

Roth 401(k) Tax Benefits