Q&A: Taxes: Now or Later?

Q:

Hey Don, I'm an avid listener. I’m 35 years old and I own my own S corp in California. I’m a Vangaurd do-it-yourselfer for now. My wife and I are the only employees in our S corp. We make about 250K each year. Currently we pay her $17.5K/yr and her entire paycheck goes to her 401K. On my side, I can pay myself anywhere between 60K to 230K through payroll, and the remainder is paid through a company distribution. Distributions are not taxed as much as payroll, but I must pay myself through payroll in order to max out, or increase, my 401K contribution up to the 52K/year. What is your advice. Should I pay myself with distributions, save on payroll taxes, and invest that money in a taxable account? Or should I pay the payroll taxes up front and max out the 401K for my wife and I?

A:

This seems like a tough call, but it really isn't. Given your age and penchant for saving, I would suggest opting for a greater 401k contribution. Those payroll dollars that go into your 401k are deducted from your taxable earnings (as opposed to paying taxes on them, even at a lower rate, today) and will grow tax-deferred (or tax-free, if you put some into a Roth 401k). At your age, that long-term deferral should add substantially to your retirement wealth. Since the payroll taxes paid today will, in large part, zero out with the contribution deduction (except the employer FICA match), you should be better off. However, predicting the future with any accuracy is impossible.