In business, conventional wisdom often suggests that more is better. However, savvy business owners can challenge this notion by strategically reducing their income. By leveraging tax laws, retirement planning, and business valuations, it’s possible to mitigate taxes, increase wealth, and enhance future financial stability—all while keeping more money in your pocket.
Below, we’ll use approximate numbers to illustrate the concept. Keep in mind, every individual’s situation is unique, so you’ll want a professional team (not just one advisor) to implement these strategies effectively. For our example, we assume a business owner with gross receipts of $1,000,000 and business net income of approximately $350,000.
1. Lowering Salary Saves on Payroll Taxes
Payroll taxes are a significant expense for high earners. By reducing your salary, you can save thousands annually while maintaining the same household cash flow.
For Our Example:
- Lowering the salary to $150,000 (a reduction of $200,000) could save roughly $9,500 in payroll taxes alone.
- Done correctly, these savings translate directly into increased after-tax income without sacrificing retirement contributions.
The problem? You just lowered your income by $200,000! However, you will still receive those funds, just as part of your business distributions on your K1. Read on to see how this can further play out to your favor.
2. Optimizing Qualified Business Income (QBI) Deductions
The Qualified Business Income (QBI) deduction allows eligible business owners to deduct up to 20% of their QBI. However, this deduction is tied to taxable income and salary levels. High salaries often limit the deduction amount.
By lowering salary and shifting income to QBI, business owners can unlock larger deductions.
For Our Example:
- Reducing the salary to $150,000 increases QBI from $130,000 to $180,000, resulting in an additional $18,500 in tax savings (assuming a 37% tax bracket).
- Combined with payroll tax savings from the first strategy, this approach can generate instant tax savings exceeding $28,000 annually—before even considering other opportunities.
3. Leveraging a Defined Benefit Plan for Retirement Savings
Defined benefit plans, unlike other retirement vehicles (such as a 401k), allow business owners to make substantial contributions toward retirement based on historical earnings rather than current salary. This means:
- Contributions are unaffected by a reduced current salary.
- Business owners can optimize retirement savings while lowering taxable income.
For example:
- A business owner with historical earnings of $350,000 can continue contributing at that level, even if their current salary is reduced to $150,000.
- Assuming a $200K deferral into the retirement plan, this would result in $74K in federal tax savings for the current year. If you reside in a state with high income taxes, the total tax savings could be even greater.
This strategy increases retirement savings while reducing taxable income.
4. Adding More Value Through Enhanced Benefits
The savings don’t stop at defined benefit plans. Additional features can enhance tax efficiency and financial stability, including:
- 401(h) Accounts for Healthcare Expenses: Pre-tax contributions can cover post-retirement, tax-free medical costs—providing a tax-free in, tax-free out scenario.
- Life Insurance within Retirement Plans: Policies funded through the plan increase allowable contributions while adding financial protection.
5. Improving Business Valuation
Strategically reallocating income into retirement contributions benefits both personal and business finances:
- Demonstrating strong financial planning can increase business valuation for potential buyers or investors.
From Less is More to… More is More
In a progressive tax system, higher income and revenue create greater potential for true financial planning to make an impact. By lowering your salary and leveraging strategies like a defined benefit plan, you can save on payroll taxes, unlock QBI deductions, maximize retirement contributions, and increase business value.
While this approach may seem counterintuitive to the uninformed, it’s a time-tested method for optimizing financial outcomes.
What’s the Catch?
An individual advisor can’t execute this alone. You’ll need a coordinated team of CPAs, attorneys, TPAs (Third Party Administrators), financial advisors, and investment professionals to ensure everything—from forms to documentation—is done correctly and in the proper order.
By taking these steps, you’ll enjoy increased savings today and greater financial confidence tomorrow.
Not sure if this strategy will work for you? Procrastination is the enemy of progress. Contact your WestPac advisor today for a brief consultation to see if you would even be a candidate for one of these concepts or possibly something completely different to help you keep and protect more of your hard-earned money.
Vladi Sasic is a Registered Principal and Financial Advisor of Park Avenue Securities LLC (PAS). OSJ: 5280 CARROLL CANYON ROAD, SUITE 300, SAN DIEGO CA, 92121, 619-6846400. Securities products and advisory services offered through PAS, member FINRA, SIPC. PAS is a wholly owned subsidiary of Guardian. WestPac Wealth Partners LLC is not an affiliate or subsidiary of PAS or Guardian. Insurance products offered through WestPac Wealth Partners and Insurance Services, LLC, a DBA of WestPac Wealth Partners, LLC. CA Insurance License Number - 0I36272. | Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. | This material is intended for general use. By providing this content Park Avenue Securities LLC and your financial representative are not undertaking to provide investment advice or make a recommendation for a specific individual or situation, or to otherwise act in a fiduciary capacity. | 7405326.1 Exp. 12/26