A ‘Simple’ Idea to Save on Taxes
For small-business owners (and their employees) SIMPLE IRAs can be a slam-dunk at tax time.
If you are a small-business owner, you may want to consider a very popular small-business company retirement plan called a "SIMPLE IRA." There is a reason why it is called "simple." It's about as easy to open as an IRA, with larger contribution limits, and opening this plan will not prohibit you from investing in a personal IRA.
If you have 100 employees or fewer, you can set this plan up. Employees, including the employer, are allowed to contribute up to $12,500 a year in pre-tax contributions, similar to a 401(k) plan. For those 50 or older, there's a $3,000 catch-up provision, allowing you to put in up to $15,500 a year pre-tax.
Here's why small-business owners love this plan.
1. It's generous. Both the employer and employees are allowed to put "all" of the first $12,500 of their salary pre-tax ($15,500 for those 50 or older) into this plan, rather than a percentage of their salary, as is the case with most large-company plans. For example, if an employee under 50 had a salary of $40,000 a year and he or she is allowed to contribute 15% of their salary to a 401(k) plan they could only put in $6,000. But in a SIMPLE IRA it’s not a percentage of their salary, so as long as they earned $12,500 or more ($15,500 for those 50 or older), they can put all of it into the plan pre-tax.*
2. It's rewarding. If the employee doesn't contribute to the plan there's no "requirement" for the employer to put any money in on behalf of that employee. If the employee does contribute, then the employer is required to match up to the first 3% of that employee's annual compensation. This means the small-business owner is only required to reward employees willing to save money for themselves. Although less popular, the employer, as an alternative, could instead make a “non-elective” contribution for all eligible employees, whether or not they contribute, equal to 2% of their pay.
3. It's family friendly. A small-business owner who has a spouse who works in the business, even part time, can make a "combined" contribution of up to $25,000 per year, all pre-tax ($12,500 each) if they are under age 50, as long as they have compensation of at least $12,500 apiece (or up to $31,000 “combined” if they are both 50 or older). Plus, the employer can do the above mentioned match of both spouses’ compensation into the plan and deduct it, since it's considered a business expense for the owner.
4. It's business friendly. This plan is free from the much more complicated ERISA reporting required with plans of larger companies. There is no requirement to file a complicated 5500 tax form, no non-discrimination rules limiting the contributions of the owner or better paid employees, and very minimal overall paperwork (am I dreaming?).
The business owner may establish this plan on any date between Jan. 1 and Oct. 1 to contribute for that year
Remember sometimes the "simple" ideas are the most effective.
*The employee would need to pay slightly more, since FICA taxes must be paid on contributions going into a SIMPLE plan. For example, to put in $12,500 the employee would need to earn approximately $13,535 to cover FICA tax.
About the Author
Mike Piershale, ChFC
President, Piershale Financial Group